Before you record your AVI, load your model into MilkShape 3D and play the animation. The AVI recorder will record the AVI movie exactly as it looks in the viewport. So make sure the animation sequence fits into the viewport. You can disable the grid, disable the axis and enable the textured mode for nice visuals.
Right-click into the viewport and choose Record AVI....
When you enter the filename, make sure you don't forget the .avi extension. Otherwise, the recorder will fail to save the movie.
Click the Save button and the Video Compression dialog appears.
From the Compressor combobox choose your favorite compressor...
I prefer DivX, which you can find on http://www.divx.com. I currently have the free version of DivX 5.0.2. Please read the documentation of the compressor you are using. Most compressors provide some configuration settings. In DivX 5.0.2 for example I used 1-pass, 780 kbps, but of course you can play with the values.
After you clicked OK in the Video Compression dialog, the recording phase starts. Make sure, no other window overlaps the viewport or you will see it in the final AVI.
When everything goes fine, you will see this message box.
But if something went wrong, then you will see this message box.
I don't know, why it might fail. It can be, that some compressors just accept certain frame formats or have other restrictions. Don't ask me why it failes. In the worst case, you can always export to Full Frames (Uncompressed) and then convert the AVI in another AVI Tool. You will find lots in the web. For example VirtualDub.
Ok, finally I want to show the benefits of video compression. If my test video is compressed using Full Frames (Uncompressed) then it becomes 20'837 kb and if I use DivX 5.0.2, 1-pass, 780kbps it becomes 200kb. This approximately 104 times smaller. If you want better quality, then increase the bitrate (higher than 780 kpbs).