The second parameter is for how well you are able to read and write the language. Use these references below.
N - for for native speakers who use a language every day and have a thorough grasp of it, including colloquialisms and idioms.;
For native speakers. You should use this template if you have lived in an xx-speaking community and employed it in all everyday situations long enough that now you have a perfect grasp of it, including colloquialisms. This means that if you moved from an xx-speaking country to a yy-speaking country at age 6, and have never again spoken xx, you should classify yourself as a native speaker of yy and not of xx, even if you used to speak nothing but xx as a child. Should you have moved as an adult, you should decide by yourself, according to your own "feel", and thus might have several "native" languages.
5 - for professional proficiency.;
You work in a field in which proficiency in the formal written language is essential, for example as a writer, a copy-editor, a language teacher, …; you are willing to give advice about language issues such as grammar, punctuation, etc. if requested (for the language of the project on which the template is used, English in this case), or to help in translations from this language (for other languages). If you also are an xx native speaker, you should use both xx and xx-5.
4 - for 'near-native' level, although it's not your first language from birth, your ability is something like that of a native speaker.;
You are as proficient in writing and understanding articles in an encyclopedic style as an average educated native speaker of xx. Since users of this template are usually not native speakers themselves (because of its wording, and because the xx template for native speakers corresponds to the same level of proficiency in encyclopedic written language as xx-4, unless otherwise specified), they might be (but not necessarily are) unfamiliar with some colloquialisms (which are generally not used in an encyclopedia, anyway), some aspects of popular culture of xx-speaking countries, etc.
3 - for advanced level, though you can write in this language with no problem, some small errors might occur.;
You are confident in writing in a language in an encyclopedic style, but may make minor mistakes, and have trouble with some of the most peculiar features of the language. You should probably only need a monolingual dictionary to understand any non-technical article.
2 - for intermediate ability, enough for editing or discussions.;
You can contribute to articles in a language to some extent, but are not confident in writing in it. Someone using this template will most likely not be fluent in a language but will understand the general idea as well as many details in an article (although a poorly educated native speaker may use this template). This template might be used by editors who have a sizable vocabulary as well as good understanding of the grammar of the language in question, but who might have trouble creating new articles or writing in an encyclopedic style. You would most likely be able to coherently translate most articles using a dictionary.
1 - for basic ability, enough to understand written material or simple questions in this language.;
You can understand a language well enough to use an article as a source for writings in your own language, and to ask and answer simple questions in it, e.g. on a user talk page (possibly with the aid of a bilingual dictionary), but are unable to contribute significantly to an article in that language.