Usually you'll simply want to format the USB drive as one big NTFS partition, or maybe two (one with FAT32, one with NTFS), according to if you're going to have it readable by Win98/95 machines.
You'll want to assign the drive letter from
"Control Panel->System Tools->Computer Management->Disk Management" and deal with their clunky interface to ensure the external HDD is mapped to something predictable.
Generally, all you really want to do with the external hard drive is mirror stuff to it. The version on the computer is the "official" version, the version on the backup drive is "mirror".
I maintain a third "archive" category, that doesn't delete files that are deleted on the computer, in case mistakes have been made. These versions will still be overwritten on the external hard disk, but if you want to 'version' them, just rename the 'archive' folder with a date, and run the batch to create a fresh archive version.
If you move work or data to the hard drive to be worked on there, then THAT is the "official" version, and you must take steps to back that data up, as well. Either back to the computer, or to another backup device, such as another external hard disk.
My external hard disk spends most of its life "off", only occasionally being turned on to perform a backup (and rarely, but very significantly: a recovery).
Another little tip: XP has a System Restore 'rollback' feature. CONFIGURE THIS! The most important thing about this 'feature' is it will restore versions of everything, as of the date, and since the date that you rolled back to.
If this includes your WORK folders, you will get hundreds, even thousands of spammy names of files when you go back to a 'restore point', and your current work will be buried somewhere among these files!
Move your 'my documents' folder to a different partition than Windows, as well as any other work, and tell XP NOT to maintain system restore information for that volume. You're backing it all up seperately, after all.
It is quite handy on the Windows partition, as the built-in recovery relies on its existence, and it lets you (relatively painlessly) back out a lot of boo-boos with bad software and driver installations.