How does the iPhone know your typing?

Like that simble comes up that shows someone's typing but is that just when the keyboard is open or when your actually typing? My friend hasn't texted back but that type things been there for hours

It comes up when you have started to write something. So your friend may have started to write back, got distracted by something, locked the phone with the sentence unfinished. When he/she goes back on the phone to sentence she unfinished will still be there waiting for her to finish it. Until that time it will look like she is still typing for ages.

And iPhone detects typing using the Internet in the same way you detect someone typing on msn

When you are writing something in the type field it will show up.

Possible your friend stopped mid-typing but as far as the phone knows its just a pause.