You can move absolutely anything and everything onto your external drive and just leave windows on your C drive thus freeing up your pc completely.
I was the same as you till I got one and didn't really understand the principles of an external but all that happens is you plug it into a USB port and it shows up on "My Computer" as another drive, say "K".
If I were you, I'd start by moving stuff to it like music, videos and pictures. They're what take up most space. Mind you, if you load a new program for example and install it in "K" instead of "C" it will still work perfectly well, possibilities endless. Word of warning though, they're not infallable and can break down like anything else. Externals tend to rely on heat sync for cooling where your pc has a fan so you can expect them to get warm, very warm sometimes so I think (just my opinion) that it's best to move stuff you don't use that much and then you can turn it on and off as you need it.
Remeber when turning it off to shut it down properly from the system tray, God, I sound like I know what I'm talking about but I don't really, it's just that I'ver got one!