Learn Russian: Мы украшаем платье цветными нитками. - We are decorating the dress with colored threads.

In Russian, the instrumental case is used to show the tool or means by which an action is done. You can think of it as meaning "by means of" or "using". Here, the threads are the physical items we use to decorate the dress, so they take the instrumental form.

How are the plural instrumental endings formed in цветными нитками?

For regular plural nouns, the instrumental ending is usually -ами, which changes the base word нитка (thread) into нитками. For plural adjectives, the standard ending is -ыми, changing цветной (colored) into цветными.

платье is the direct object in this sentence. Why didn't its ending change?

You are correct that платье is the direct object and is in the accusative case here. However, платье is a neuter noun. For neuter nouns, the accusative form is always identical to the nominative (dictionary) form, so the ending does not change.

Does украшаем mean "we decorate" or "we are decorating"?

It can mean both! Russian does not have a separate continuous tense like English does. The verb украшать is imperfective, which means it describes an ongoing, incomplete, or repeated action. In this present tense context, "are decorating" is the most natural English translation.