The hotspot is the object's xy position as far as the game engine is concerned. The image of the sprite is drawn relative to the hotspot. So if the hotspot is at (0,0) on a 16*16 sprite, and the sprite is at (100,100) in the game, then it will be drawn in pixels (100,100) to (115,115). If, on the other hand, your hotspot was in the centre, your sprite would be drawn from (92,92) to (107,107), or there abouts.
You can use this to trick the player into seeing a 2D world that appears 3D. Imagine looking down on your game world from directly above at 12 0'clock, with the shadows of the objects acting as collision masks. If you were to tilt the camera upwards the shadows would appear below the objects and any objects off the ground would appear further from their shadows, but the game would still see the world in terms of the collision masks (i.e. the shadows).
I think a diagram may explain this far better than mere words, but I've been playing MegaMan 9 all night so I didn't get around to making that example I promised. It's coming, I assure you.
Can't help with that aiming issue though.