1. I'm running windows xp on my pc, and I have a seperate external hard drive that I wish to install linux on. Once I've installed this I would like to start up windows, and then run Linux on top of this (within a window or something). Is this possible?

Not as far as I know.

2. What is the best variation of linux? (i'm quite confused but it seems people have made different versions of it)

If you are just starting out use Ubuntu, it's very easy to install and use.

3. What are the essential applications for linux? - any good ones, i.e. video editing?

All of the applications which are essential are pre-installed but all others which you might need can be installed easily with their premade application installer.