ok I finally got it to work.
BUT the down side is that I had to go through all that walk through at http://docs.cksource.com/CKEditor_3.x/Developers_Guide/File_Browser_(Uploader)which is at some point very difficult to understand.
any how it's working fine for now and I think it might be the best choice for now, because it's an addon for ckeditor.
Although I realized if you have another file uploader of your own you can add it to ckeditor, I don't think it would be that difficult.
haven't tried that yet.
with the current version 1.4.1 image and file upload has already been included :)
see admin -> plugins -> WYSIWYG Editor --> Allow images to be uploaded
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