Too loose and your weight isn't distributed as evenly as it could be. Also, too loose means a lot more curvature, which puts strain on your knees (or so I've found, as I have a testy knee).

I think I'd say you know when it's set up properly when you feel almost weightless in that the hammock suspends your weight evenly. I wouldn't go by pictures of hammocks that have been set up as many are way more loose than I'd consider livable.