There are ways to test it.
With the auto hubs, the easiest thing I can think of is to put it in 4-Hi (push the 4x4 button) and then jack up the front end. Rotate one wheel by hand and the other wheel should rotate in the opposite direction. There are other methods, but that's the only one I can think of right now.
How to use it properly - that's a harder question to answer only because I'm not sure what you mean by that.
Frst off, never engage 4WD while on high traction surfaces (asphalt, concrete, etc). You can cause the driveline to bind which puts stress on the entire driveline, but especially the transfer case. Transfer cases have been known to break as a result of the extra stress.
From 4x4abc.com:
You would select 4WD high on snow and for easy to moderate off-road (dirt roads, easy trails). You would select it to have better use of traction (better than 2WD) to get going and to maintain forward movement with a reduced risk of slipping and spinning wheels.The added lateral stability of 4WD makes it less likely to slip sideways.
When "4-low" is selected the wheels create substantially more torque than in "4-high" - at the same time the vehicle moves at substantially slower speeds.
Important: "4-low" does not create more traction - it creates more torque and that can be detrimental when traction is marginal. Slipping tires are more likely in "4 low" than in "4 high"! For that reason 4 low is not a good choice for snow or ice - and not a good choice for mud either!
On pavement the 4 low setting is an advantage for drivers who need to tow and maneuver a heavy trailer (ideally it would be full time 4WD low for towing) etc. and for drivers who at one point or another may want to negotiate difficult off-road terrain, when more torque and/or slower speed is needed (when off-road, part time 4WD low is best - full time 4WD low will not do well, unless the center differential can be locked).
As for the manual hub conversion:
The "Automatic Hublocks" are adequate provided that they actually work. Over time the aluminum rings inside the hubs can wear down or break, or another common reason they don't work is that someone took them off and packed them with grease which causes the hublock to not be able to engage.
When you do a conversion, you have to buy a set of aftermarket hubs (Warn & Mile Marker are typical brands) and axle nuts that replace the auto hubs.
Auto hubs rely on the rotation of the wheel independent of the axle shafts for a short distance to engage two separate components in the hub - when the two components slip into place, they lock together which causes the axle shaft to turn the wheel. They are prone to breaking under high torque situations and can become unlocked easily.
Manual hubs require you to turn a dial on the end of the hub. Turning the dial has the same effect - you're locking the wheel to the axle shaft. The difference is that once you lock it it's locked until you unlock it again. Of course, if you break the hub itself, it'll unlock but at that point you've got bigger problems. One downside to manual hubs is that you have to actually get out of the vehicle and lock each wheel...if you're already stuck in mud or water, it's not fun to have to mess around with the hubs.
This thread goes into greater detail about auto / manual hubs:
http://www.explorerforum.com/forums/showthread.php?t=232754