"Literal" in this context means "word-oriented"—communicating the explicit meanings of individual words and phrases rather than the implicit meaning of the text as a whole. The opposite of a literal translation is a liberal translation—one that takes many liberties in interpreting the text, paraphrasing statements to make them flow naturally in English and generally bring the text into the comfort zone of the reader. In contrast, a literal translation makes only minimal alterations to the text, leaving the task of interpretation up to the reader.
Isn't That Just a Bad Translation?
It's not what most people expect from a translation—most people want the text sound as if it was originally written in English—but for people who enjoy studying text and coming to their own understandings, a literal translation provides the raw material for a more informed interpretation. A all-around bad translation is one that misrepresents its source on both a literal level and an idiomatic level. Official localizations of games usually hew to the liberal approach because of its broader appeal, and that's for the best—but this isn't an official localization! We're not trying to supplant any existing standard versions, only to offer a specialized alternative. There's room in the world for more than one translation; in fact, the best way to come to the fullest possible understanding of a text* is to refer to multiple translations, both literal and liberal.
*Short of being fluent in Japanese, of course!
How Does This Relate to Touhou?
The text of Touhou Project is, from a translator's perspective, capricious and unruly, full of untranslatable wordplay and weird grammatical lilts that require significant lateral thinking to communicate concisely in any language other than Japanese. The current main English translations of many of the games are the horrifically messy product of years of tweaking, varying wildly line-by-line in their approach from far too literal to far too liberal. The goal of this project is to move the literal translations into their own version, clean them up, and annotate them for clarity, so that the main translations can be moved in a more liberal direction.
Sometimes it's impossible to avoid inserting a word here or there into the translated text, for the sake of disambiguity or even elementary grammar. Because Japanese is a relatively terse language and English a relatively verbose one, Japanese-English translation requires lots of insertions. To prevent these from becoming artifacts, all insertions should be marked with italics, including ones as simple as "a" or "the"—any word or phrase that does not directly correspond to some word or phrase in the original text counts as an insertion!
Sometimes it's beneficial to retain a non-English word without translating it at all. This should be done sparingly—unlike insertion, retention is rarely necessary, and when committed excessively, is the mark of a lazy translation. As foreignisms, all retentions should be italicized in accordance with standard English style. This does not apply to character names.
As a corollary to the above two conventions, don't use italics to indicate emphasis!
Full names are to be given in the Japanese order, with the surname first and the given name second—it's Hakurei Reimu, not Reimu Hakurei. Unless, of course, the name is already in the European order in the original text—Margatroid Alice would be very silly.
Honorific suffixes (-san, -chan, -sama, etc.), when attached to names, should be retained. Honorific epithets (ojou-sama, sensei, etc.) should be translated.
All romanizations should adhere strictly to modified Hepburn, with the modification that long vowels should be represented as diphthongs rather than with diacritics—it's Gensoukyou, not Gensokyo or Gensōkyō.