How to shrink tablespace using toad for oracle and how it works?

Technically, you don’t shrink tablespaces, you shrink datafiles. A tablespace contains one or more datafiles.

Anyway, to shrink, you can find the tablespace in the Schema Browser, then go to the right hand side where the files are listed and double-click on the file that you want to shrink. Click the “Minimum Size” button to find out what is the minimum size that you can shrink it to. Enter the new file size in the dialog that appears and click OK. Toad will issue a command like “ALTER DATABASE DATAFILE ‘c:\path_to_file\file.dbf’ RESIZE 100M;” and Oracle will resize it.

…small addition to John’s reply:

all of that can be run online (when database is up and running) with no circumstances to any running session.