On the loom
The dropped stitch is as easy as the first stitch you probably learned — the e-wrap. Knit your first peg. Next, e-wrap that same peg as many times as the pattern dictates. (You might run out of room after four wraps though.) DO NOT knit over the e-wraps. Continue onto the next pegs in the pattern. When you have completed your row, you should have several wraps secured on each peg.
If you are knitting in the round, you can continue onto the first peg in the next row. First, pick off the extra loops you e-wrapped. Don't worry, you won't lose your stitch. Then knit the peg and continue on.
If you are knitting flat, like these scarf squares have been, you won't be able to release the e-wraps on Peg 1 on this row. That is because they haven't been secured. So you're going to skip (slip) the first stitch and you'll release those e-wraps on the next row.
As you release your wraps, tug gently to pull through the dropped stitches. They will hang nice and neat.
Normally, dropped-stitch patterns have several rows of garter or stockinette between. Just for a different spin, I used seed stitch instead.
Dropped seed stitch
Multiple of 2 sts. plus edge sts., knit flat
Row 1: *(K1 P1), rep from *
Row 2: *(P1 K1), rep from *
-- Repeat Rows 1-2 four times or as many as desired. --
Row 9: *(K1, e-wrap 3 times), rep from *
Row 10: *(Drop 3 sts., K1 on same peg), rep from *