Get a VOM (Walmart has some for about $10) and start checking the resistance and continuity.
- With the sensor installed, check resistance between the sensor body and a good ground on the engine block. It should be zero. If not, then you need to ground the sensor and/or the head to the engine. This verifies that the sensor is properly grounded.
- With the sensor installed, check the resistance between the sensor terminal and engine ground. From what I recall, it should be 0 ohms with a cold engine, and rise to 90 ohms at the max scale. If it changes with temperature as the engine warms up, then the basic sensor operation is good (although sensor/gauge calibration may still not match).
- Disconnect the sensor wire and with the ignition on:
-- Verify that you have 12 volts on the sensor wire when the ignition is on.
-- Put a 10 or 20 ohm resistor from Radio Shack between the wire and engine ground. You should get a low gauge reading.
-- Then try the same thing with a 90 ohm resistor and you should get a high reading.
If it passes all the above tests its basic functions are working; however, if the gauge itself is off calibration or the sensor has the wrong resistance range (e.g. Fords are different) then you may still be getting readings that are off.