Amy wrote a GREAT post about felting a while back....boy, am I glad that I copied it and saved it on my hard drive, as I can't find it for the life of me!! Here is what it said:
Here's just about all I know about felting!
Felted projects are usually knit on larger needles than normal for the yarn. They also shrink dramatically, and the rate at which they shrink is dramatically different for different yarns, so it's best not to combine different yarns if you're going for consistency; unless you've done a test felt and confirmed they have the same rater of shrinkage. Remember to use wool or other animal fiber. You can test to see if the fiber felts, by trying to make a felted join, as on the basic techniques/ more page. Wool will always felt, but wool blends and other animal fibers you probably want to test.
Be aware that felting can dramatically change the proportion of your item. Felting shrinks more height-wise (over the rows), than it does width-wise (over the stitches).
Here's a useful link for figuring out the math from your own test swatch, to determine how many stitches to cast-on. I've had similar results as the sample given, in my own felting experiences. Here's my own numbers, using knitpick.com's wool of the andes yarn, and size 10 1/2 needles. I started with a gauge of 3.5sts and 4.75rows to the inch, in stockinette. (The yarn is normally knit at 4.5sts/inch, but it's done bigger for felting.) I wouldn't worry about having an exact guage to begin with; if it's too big, you just felt it longer, ya know? If you've knitted with smaller needles, like those normally used for the yarn, you can still try to felt it. I imagine you'd just felt it less.
Here's how I figure out how big to make something. These numbers are based on a test swatch I did. I've found that the shape of the object can affect how it's felted when done in a washing machine, so this is not fool proof. I used a top-loader washer, and hot water, and two pairs of jeans , or other objects to add friction without adding lots of lint to your felted project. Soap is not necessary, and I imagine it may felt better without soap; but I've also felted with soap, so do what you like.
Size is in inches...
For good, well-felted, slightly dense finish:
Stitches: (desired size) x 1.2 = pre-felting size.
Rows: (desired size) x 1.42 = pre-felting size.
For very dense felting:
Stitches: (desired size) x 1.43 = pre-felting size.
Rows: (desired size) x 1.78 = pre-felting size.
I'm going to make a large bag based on these numbers. I may tweak these numbers when I'm done. We'll see how accurate they are for a larger object. The biggest challenge with figuring out these numbers, was that the square test swatch looked hour-glass shape in the end! I dont' know why that was! I took the measurement of the most shrunken area; so we'll see if that holds true for the actual project.