Just to clarify it a bit, suppose I want to fly from AUS-SEA. There are no nonstop flights, so I either have to fly AUS-DFW and then on to SEA or AUS-IAH and then on to Seattle. Let's say I choose to fly AUS-DFW-SEA.
AUS would count me as an O&D passenger because AUS is my origin, or where I am beginning my trip. SEA would also count me as an O&D passenger because SEA is my destination. DFW would count me as a connecting passenger, because I am neither starting nor ending my trip at DFW.
Daily O&D traffic on a particular city pair is important to the airline because it lets them know, on avereage, how many people per day are flying between City A and City B.
Using the AUS-SEA example above, during 2002 approximately 260 people traveled daily between AUS-SEA. Keep in mind that's in both directions. About 130 people a day fly AUS-SEA and about another 130 per day fly SEA-AUS.
Years ago, if you wanted to fly between AUS and SJC the only way you could do so was with a connection. There were no nonstop flights. During the dot com boom though, so many people were traveling that route, that AA decided to offer some nonstops between the two cities.
It's cheaper for them that way because they only have to check you in once and they don't have to pay for the added expense of transferring your luggage at the connecting point.
Hope that made sense.