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2) DO NOT install steam itself on an external drive. Steam needs to install a service that is based on teh installation point of hte main exe. This service will fail and do terrible things when it gets the rug pulled out from under it if you disconnect the drive.
Note that if you insist on doing this
1) Install steam itself on the LOCAL drive. This ensures the service is created properly and will not implode if the drive is disconnected
2) Create a steam library on the external drive
3) Make the external drive the 'default' library to install to. This way most games will automaticaly install to the external drive even if you click through the installation of a game.
Note that steam DOES NOT like it if the external drive is disconnected while steam is running. It will detect the library as missing and obliterate the internal mappings that show the game is installed. You can install games onto an external drive, but be mindful sthat steam does not support this and things can and will go wrong if you do (aside from the obvious performance issues with loading games from slower external drives over usb)