I am running squid and verified it works.

I have setup DansGuardian and verified it works with the default block list.

I downloaded the blacklist from here http://urlblacklist.com/?sec=download

I not have many new sub-folders within the blacklists directory. Like ads for instance.

I cat on the domains file in the ads directory and see many domains.

I run dansguardian -r and then go to a site like espn and get bunch of ads. I next go directly to url listed in the domains file and I get crap. How to setup this to always block urls in the ads.

What have I missed?

Well, if you go to "misc > Use Custom Banned Image File" and "misc > Custom Banned Image File Location" you'll find related config, but I presume that will replace ads with blank images, _and_ block some complete pages including too much ads, or including too much forbidden ones.

EDIT: You might be interested in Adzapper (plugin for Squid).