If you used an external SCSI or SATA drive, then yes it's possible.
Just to be clear about this issue there are two different conditions. First
you cannot install XP/Vista to drives defined as "Removable". It's not a
question of external location it's the removable trait that prevents it.
While I've never set it up, USB drives can be made bootable &
several web sites have published procedures to get XP running on a USB
drive. However, even if it boots it would run "Very Slowly" as on a good
day a USB drive struggles to reach sustained throughputs above 25 Meg.
(UDMA Mode 1) Fred Langa ( a questionable source ) has written a
few articles on booting from USB devices.
If you are interested in external drive booting, I'd suggest a SATA or
eSATA setup. Check at CompUSA for an AcomData unit. Comes with
PCI card, Cable and external enclosure with a WDC 200+ Gig drive.
Many of the latest motherboards now have an eSATA port on the
backplane with the traditional connectors/sockets.