Cache memory is a small, high-speed memory located between the CPU and main memory. It stores copies of frequently used instructions and data to accelerate access times. There are three levels of cache - L1, L2, and L3 - with L1 being the smallest and fastest, located directly on the CPU chip. Cache memory utilizes the principle of locality of reference, where programs tend to reuse the same data and instructions. This allows the cache to improve performance by retaining recently accessed content.