The PS3 uses FAT32, which will address up to 2TB of hard drive space, so that's the limit on hard drive size. Just be aware that it needs to be a 2.5" SATA drive (basically a laptop hard drive). 5400 or 7200RPM drives both work fine, but of course there's a small boost of shortening load times with the 7200...since a lot of games will have you installing some stuff on the HD for faster loads.
External drives (or even thumb drives) will work fine. Just be aware that the drive will have to be formatted to FAT16 or FAT32 as well.
Other media stuff... if you have media XP computer or better, you can allow that computer to share media and play it through the PS3 straight from the menu. And if you're interested in Netflix in HD, or the upcoming Hulu Plus, that's an option as well.