In fiction, I much prefer foreign words not to be in italics. Being foreign already makes them stand out, adding italics makes it even more distracting.
I also like to use well-known foreign words, like 'Dieu', 'nein', 'sayonara'... On the other hand, I speak two languages fluently, understand three other very well, and know basic words in another two. What I think is a well-known word may not be so for most people. To address this, I try to ask a variety of people and see if they think it's well-known. If they turn out not to be that famous, I treat them as general foreign and follow the methods below.
These methods are based on context and translation. A few examples using a made up language so it'll work for anyone:
1. context only
Juphtay, the young Martian who'd just arrived, was putting away some crates when one fell on his foot.
"Lert!" He yelped and glared at the crate.
That must be an expletive of sorts. This approach works well only for expletives, insults or amorous words. Say...
Jophtay held his wife and whispered 'nahrthnee' lovingly.
After you use it in a clear context several times, you will be able to use them again and expect the reader to more or less remember their general idea.
2. context with a little help from the narrator
Juphtay was completely focused in his cooking.
"Oun frags, aal frags..." he mumbled as the milk he poured into the measuring cup went from two centilitres to four centilitres.
Again, you can tell he's speaking up the measures. This particular example is rather weak but you get the idea. This approach works best in situations where characters are so engrossed they're speaking their minds unwittingly as they do something, or they are following instructions and saying them out loud for themselves (at least I do that in real life) or to someone else. Say...
"Nagty bwork un pleryith," Jophtay said, and Anna quickly inserted the key in the little hole on the wall.
This can get a bit mixed up with number 1 (context only).
3. narrator translates for the reader
Juphtay grumbled in his native martian against all the mosquitoes buzzing in the warm evening.
Or...
Juphtay quickly wrote a message in a Martian shorthand his boss had invented. The human who was in charge of the warehouse was embezzling. Soon he'd have the necessary proof and he'd need a couple of agents to stand ready to assist him once he did get that evidence.
This works best if no one else is supposed to understand what's being said except for the reader.
4. The whole dialogue is translated
"You really must be careful," Jophtay told Anna in slow, careful Martian so the young human female could follow. "If these people realise you're spying them for me, they may attempt to kill you."
As number 3, essential information for the reader that must be passed on without doubts.
5. Another character translates for the reader
Through the character's thoughts...
"Jophtay!" Anna crossed her arms as she stopped at the doorway. "What do you think you're doing?"
"Larm acht phatorney-up leertun!"
Anna glared at Jophtay. She knew full well he was just reading a magazine, that was the whole point! It was an English magazine and he wasn't supposed to show everyone around he could read in that particular language.
Or in direct speech...
"Larm acht phatorney-up leertun," Jophtay said.
"So you're reading a magazine, so what? Everyone reads magazines."
Or in indirect speech...
"Larm acht phatorney-up leertun," he said over the phone
Anna sighed and once more told him he shouldn't be reading magazines. He knew it was dangerous.
This approach works well if the foreign dialogue isn't very long or information heavy.
Those are the ones I most use. If I can think of more I'll edit them in.
Edit
Oops, I overlooked the second question:
Should such unfamiliar foreign words be avoided in the first place?
Personaly, I like the judicious use of foreign words. If a character is foreign, then dropping at least a few foreign words every now and then helps to create the right feel and image. As I said above, I'd rather they aren't in italics in fiction, and I do dislike if they are abusively used (meaning dropped without any hint to meaning or even just general feel), but no, I don't think they should be avoided per se.
