It won't work. Windows MUST be on an internal drive to work.
So clean up some of your drive. Moving your iTunes library to an external drive is a good step (and a good idea too!)
Now someone will come along and say "if you do this, then that, then this other weird thing, you CAN get XP to install on an external drive-mostly." Some major portion of the OS still must be on the internal drive, and the "this, that and the other" stuff is certainly not for the faint of heart!