To create a 120x80 pixel drawing using the 1-pixel pencil tool in Photoshop, save the file as a JPEG in OneDrive, and optionally draw a pet. The document then explains how to animate layers by creating a new layer for each part, using the timeline to add keyframes for movement with arrow keys, and showing/hiding layers in each panel. It concludes with resizing the final animation to 1080 pixels wide using nearest neighbor interpolation.