NTFS encryption
The Encrypting File System (EFS) on Microsoft Windows is a feature introduced in version 3.0 of NTFS that provides filesystem-level encryption. The technology enables files to be transparently encrypted to protect confidential data from attackers with physical access to the computer.
Source: Encrypting File System
Folder encryption
Windows does not really encrypt folders: when you enable the encryption option, all you're doing is forcing new files created inside to be automatically encrypted. Quoting Wikipedia:
Folders whose contents are to be encrypted by the file system are marked with an encryption attribute. The EFS component driver treats this encryption attribute in a way that is analogous to the inheritance of file permissions in NTFS: if a folder is marked for encryption, then by default all files and subfolders that are created under the folder are also encrypted.
Source: Encrypting File System
If you don't want the folder content to visible at all, you need to change the Access Control List (ACL) permissions from the Security tab of the folder properties. Even if someone else were able to change the permission and see the files, he/she couldn't open them anyway.
Note EFS is not fully supported on Windows 7 Starter, Home Basic, and Home Premium editions.
Further reading
Full encryption
If you need true disk encryption, you should probably look into BitLocker (only available on the Ultimate and Enterprise editions), or a third-party solution like TrueCrypt.
TrueCrypt - update
The official TrueCrypt website now reads:
WARNING: Using TrueCrypt is not secure as it may contain unfixed security issues
This page exists only to help migrate existing data encrypted by TrueCrypt.
The development of TrueCrypt was ended in 5/2014 after Microsoft terminated support of Windows XP.
Further reading