You crouch-jump, and shoot a rocket at your feet.
Make sure you're as far as possible from the ground the moment the rocket hits the ground to make sure you're not damaged too much. The last part might take some practising.
By the way, Valve has included a training weapon in the game called the Rocket Jumper. With it, you get twice the ammo and no self-inflicted damage. It's not useful out in the field, really. It can be crafted or bought in the Mann-Co store for $0.49 / £0.29 / €0.49.
(Powerlord mentioned this in the comments to the question above)
The compression blast range appears to be slightly shorter than the range of your actual flamethrower, from personal experience. You can compression them anywhere within that range and you'll reflect. The angle that it gets reflected back at is dependent on where your cross-hairs are aimed when you hit the compression blast.
Additionally, for grenades, there appears to be some determining factor with return velocity depending on your distance from them. I can't find a lot of info about that though.
Rockets will travel indefinitely until they hit an object. Arrows seem to function similarly to grenades, but less noticeably so due to their natural high speed and lack of "bounce".
In regards to lag compensation, the compression blast is NOT lag compensated. You're going to have a harder time reflecting rockets / grenades / arrows if your lag is higher, especially when dealing with the higher velocity ones like the Direct Hit rockets and arrows.
Edit: As per the link in the comments, edited the above to indicate that the compression blast is NOT lag compensated.
It's hard to say "when" you should compression blast. It's a function of distance and velocity, rather than time from fire. With any projectile, it's nearly impossible to reflect at short range without some sort of luck / godly reaction speed. At longer distances, the Direct Hit and arrows can still be relatively difficult to reflect. Again, it's about the distance, not the time before it hits. The best way to get a feel for it is to play it and learn it intrinsically, not go by a paradigm that there's a hard rule for timing it based on seconds.
Best Answer
Critical hits and mini-crits do not deal additional self-damage (despite the "you got crit" sound playing). Reflecting an explosive and making it a mini-crit therefore does not increase the damage it would do to you.
As a result, reflecting it is always better than just letting it hit you. If self-damage reduction applies, it's the obvious choice knowing that the mini-crit status has no effect. If self-damage reduction does not apply, you'll still have the chance to push it slightly farther away.