pg_hba.conf - md5

I want to access by postgre db over the internet. My pg_hba.conf if
setup to do this:
host all all 0.0.0.0/0 md5

Now, what I don't understand is how does the "md5" effect things?

If I connect via php:
$db = pg_connect('host=xx.xx.xx.xx port=5433 dbname=MYDB user=postgres
password=mypass');

"mypass" being whatever my password is; is still set in plain text?
Why don't I have to send the md5 version of the password to connect?

Thanks,
Vince.