Circuit Diagram
The LEDs are arranged so that when the polarity across the circuit is one way only one LED will light and when the polarity reverses the other LED will light, therefore when no transistor is connected to the tester the LEDs will alternately flash. The IC2 outputs are also connected to resistors R4 and R5 with the junction of these two resistors connected to the base of the transistor being tested.
With a good transistor connected to the tester, the transistor will turn on and produce a short across the LED pair. If a good NPN transistor is connected then LED1 will flash by itself and if a good PNP transistor is connected then LED2 will flash by itself. If the transistor is open both LEDs will flash and if the transistor is shorted then neither LED will flash.