How to setup Windows from an external hard drive?

Follow the directions here:

1. Plug-in your USB flash drive to USB port and move all the contents from USB drive to a safe location on your system.

2. Open a Command Prompt with admin rights. Type "cmd" into the Start menu search box and hit CtrlShiftEnter.

3. Type DISKPART and hit Enter … Next type LIST DISK and note down the Disk number (e.g. "Disk 1") of your USB flash drive.

4. Next type all the below commands one by one.

   SELECT DISK 1
   CLEAN
   CREATE PARTITION PRIMARY
   SELECT PARTITION 1
   ACTIVE
   FORMAT FS=NTFS
   (Format process may take few seconds)
   ASSIGN
   EXIT
   

   Don’t close the command prompt as we need to execute one more command at the next step. Just minimize it.

5. Next insert your Windows7/Vista DVD into the optical drive and check the drive letter of the DVD drive. In this guide I will assume that your DVD drive letter is “D” and USB drive letter is “H” (open my computer to know about it).

6. Maximize the minimized Command Prompt in the 4th step.Type the following command now: D: CD BOOT and hit enter.Where “D” is your DVD drive letter. CD BOOT and hit enter to see the below message.

7. Type another command given below to update the USB drive with BOOTMGR compatible code.

   BOOTSECT.EXE /NT60 H:
   

Where “H” is your USB drive letter. Once you enter the above command you will see the below message.

8. Copy your Windows 7/Vista DVD contents to the USB flash drive.

9. Your USB drive is ready to boot and install Windows 7/Vista. Only thing you need to change the boot priority at the BIOS to USB from the HDD or CD ROM drive. I won’t explain it as it’s just the matter the changing the boot priority or enabling the USB boot option in the BIOS.

You can use an external USB hard drive or flash drive. The steps to install from a USB hard drive can be found here:

Use a USB hard drive to make a bootable Windows 7 install