Start in the PREFERENCES > ADVANCED > IMPORTING section.
If you’re going to stay with iPods or the Zune, I’d go with this setting for compression: AAC (Higher Quality) 256 kbps
If there’s any chance you’ll be moving your music to who-knows-where in the future, go with this: MP3 (Higher Quality) 192 kbps
The first choice is better, the second is more compatible with other devices. I go with AAC, but those are your two best bets.
Next, go to PREFERENCES > ADVANCED > GENERAL. Make sure that “Keep iTunes Folder Organized” is checked. Then, make a folder on your external drive and click the “Change” button there to select that folder as your music’s home.
Now, any future imports will go there. To move all your current music, go to the “Advanced” menu (in iTunes, not Preferences) and select “Consolodate Library.”
That will move everything in your library to the new location. Your iTunes library and playlists remain in your home folder on the internal drive, but all media goes to the new folder you’ve set on the external drive.
After it consolodates, check the music folder in your home directory. I THINK that the music will still be left there. Find the folder with the sound files and erase the contents of that folder, leaving everything else you find (iTune files) intact outside of that folder.
While those files are in the trash (but BEFORE YOU EMPTY THE TRASH) test iTunes and make sure it’s playing the media from the external drive just fine. If it works, feel free to empty the trash and erase the original music.