The quote is incomplete. It needs the full context.

"Varys: But if it's swordsmen who rule, why do we pretend Kings hold all the power? When Ned Stark lost his head, who was truly responsible? Joffrey, the executioner, or something else?

Tyrion: I've decided I don't like riddles.

Varys: Power resides where men believe it resides. It's a trick, a shadow on the wall, and a very small man can cast a very large shadow.

Essentially what Varys is getting at is that power, in the way that most people understand it, is a trick--an illusion. Most people view power as being this very public thing, defined by ancient bloodlines, extravagant titles, and lots of money. As a result, the most "powerful" men are the ones with the most of the three things listed above.

But again power itself is a trick and a illusion. Meaning that superficially these men are the most powerful, but the reality is that their power is casting a "shadow" that conceals the true power behind these men--which are guys like Varys--guys who hide in the shadows of "powerful" men.