Looks like you're running DS-5 on Windows. I'm using DS-5 on Ubuntu. Things should be very similar if not identical.
This is where you need to determine which hardware debugging method you will use. I'm using the CMSIS-DAP, which is just a USB cable connected to J3 on the CPU board. I think this is what you want to do, too. I think that orange/yellow LED should NOT be on and it certainly should not be flashing. If it is, then the board is not configured correctly for CMSIS-DAP debugging. It is probably configured to act as a UART-to-USB port. On my board, the LED is not lit.
In any case, you need to configure the board for CMSIS-DAP debugging and that means you have to load new firmware on it. For that, you need the firmware and instructions on how to do it.
You need to find "TWR-VF65GS10-QSP.zip". Go to Freescale's main webpage and put that into the search box there. It should take you to a download page. It contains a nice little PDF guide, "Vybrid DS-5 Getting Started Guide". Follow that guide and it will take you through most of what you need to do (I think you are already reading that). It has a lot of good information. That zip file also has the firmware you need for the Freescale K20 CPU (which is on the bottom of the board). In the "OpenSDA" folder of that zip file, you'll find another PDF file that will give you some info about what this is all about. Unfortunately, it doesn't tell you what to do. For that, you need to download the OpenSDA User's Guide at:
http://cache.freescale.com/files/32bit/doc/user_guide/OPENSDAUG.pdf
Just one thing you should know. In that .zip file, you are interested in two of those firmware files: CMSIS_DAP.S19 and VIRTUAL_SERIAL_PORT.SDA
The first firmware file is what you will need to load onto the K20 to be able to program the Vybrid and debug it.
The second firmware file is what you will need to turn the K20 into a serial port (via USB) to your computer. However, in order to do this, you'll need the elevators as well as the TWR-SER2 module. There are other ways to view the serial port if you didn't buy the entire tower system.
Note that you cannot have the CMSIS-DAP debugger *and* the serial-to-usb functionality at the same time. It's one or the other. It got to be such a pain for me to switch back and forth, I just connected some wires from the board to an RS-232 transceiver and left the CMSIS-DAP firmware loaded in the K20 full-time.
Once you get that K20 configured as the CMSIS-DAP debugger, you will configure DS-5 to use that connection. In the "Debug Configurations" window, you will hit "Browse..." under "Connections". If you have selected "CMSIS-DAP" under "Target Connections", it should see the board. you just select it. At this point you are ready to debug and the "Debug" button should not be greyed out any more.