Mountain bike disc brakes are a relatively new and useful invention. Whereas older-style rim brakes worked well in dry conditions, in wet and muddy conditions their braking ability began to falter. Disc brakes work regardless of the conditions, as the braking mechanism (a metal disc is grasped by two metal brake pads) is much more stable and reliable. However, adjusting these brakes is not nearly as simple as adjusting their rim brake brethren. There are a series of steps to go through to adjust mountain bike disc brakes to ensure their long and useful lives.
Use the Allen wrenches to loosen the brake caliper mounting bolts so that the brake calipers will move around a bit on their mounts. Squeeze the brake levers tightly, and then use the Allen wrenches to retighten the mounting bolts. This centres your brakes on the discs so they do not drag when the wheel is spinning.
Unscrew the barrel adjuster located on top of the brake caliper until you feel the pads touch the disc, then screw the adjuster back in one full turn. Screw down the barrel adjuster stop nut to lock the adjuster in place.
Unscrew the barrel adjuster on the brake levers until you feel the calipers touch the disc again. Now screw the adjuster back in one full turn and lock down that barrel adjuster with its stop nut. This should give you enough play in your brake lever to comfortably squeeze the brakes. Take the bike for a spin to test out your newly tuned brakes.
Be careful on your test ride; your brakes should now be extremely tight and touchy, because there is so much less play in the system, which you may not be used to.