This is a post from my old blog from 2007, but I thought it was worth sharing again.
Put the water soluable fabric into a hoop. Put the hoop under the presser foot and press the pin through the fabric (I have to take the foot off to do this, then replace it.) Put a piece of rubber/eraser/blue tack onto the point of the pin.
Lay your piece of confetti fabric, (or whatever fabric you want to show on your circle) onto the hoop and stitch with a standard straight stitch. Try not to touch the hoop, let the machine do the work. (There is only soluable fabric in my picture so that you can see what is happening)
Take the hoop off the pin and out of the machine. Carefully cut around the straight stitches as close to the stitching as possible. Do not cut the soluable fabric. Put the hoop back, replacing the piece back onto the pin in exactly the same place as it was before. Set the machine to a close zig-zag, just wide enough to cover the cut edge and straight stitching. Stitch, letting the machine/hoop/pin do the work.
Take it out of the hoop, cut away the circles and disolve the soluable fabric.