I've been using a Western Digital 120GB external (w/USB 2.0) about 18 months now. Single-player games = no problem. Multiplayer = a bit laggier than on my native HD.

MS Flightsim 2000 plays fine; no experience with any newer flightsim products, so no advice given there.

I think you'll be fine using extHD; the fellas above give good advice about how it connects to your rig - USB 2.0 is a heckuva lot quicker than 1.1. Good luck!