I am looking to install a linux distro (Dont really care what at this point, I am looking at DSL, since its the only one that also can run under windows that I know of), that can boot off a USB drive, and also run inside of windows.
However, I dont want it to act like a live install, I want it to change the USB drive directly, either under windows, or booted of the drive. So I can keep files/settings and such, without any hasle.

I did get DSL installed onto a USB drive. However I cannot figure out how to make it act like an HDD install.

I am trying to find a way to use the "Intall to HDD" tool in DSL inside windows, to install it onto my USB drive.
But I cannot figure out how to mount it.

I wont be able to intsall it by booting dsl, because I can't boot from DSL, it freezes at the boot line "hde: attached ide-disk driver"
I learned that DSL does not support SATA HDD's, or it does not support more than 2 IDE controllers (I have 3 being used) which I just recenlty insalled.
If it came down to it, where the only way would to be booting into DSL, then I'll just disconnect the SATA drive.

But, again, any distro will do. I have no preference one way or the other. If you know of a better one that can accomplish this, please tell.



EDIT:
I also forgot to mention, I tried Slax, but that also wont boot. It says "could not find kernel image linux"

I have talked about Puppy Linux on more than one occasion. It resides inside of windows in a folder. It can also be ran in multisession mode, where is writes changes and data to the same CD\DVD the image is burned to. I use it for my dedicated Chat computer and run GAIM. It will boot from almost any media, USB, LS120, ZIP, Flash, hard drive,..
It is only 60 mb, give it a try.

WOW! Thanks, I found just what I was looking for
http://www.erikveen.dds.nl/qemupuppy/index.html#2.0.0

Only complaint is that its based on Puppy 1.09.1. Rather than the new 2.01. Maybe I can update it?
Although QEMU-Puppy has a lot of edited scripts.

This is great. I just got it loaded up. It doesnt seem to commit changes in a Virtual Environment, but I havnt tried yet. However I think it is supposed to do so if its booted from a USB, everytime it shutsdown.
I'll soon find out, I just installed my usual firefox extensions.

It runs, faster, and looks a nicer than win2k. I love it. And its a ton eaiser to use than Damn Small Linux, and its only 25mb more.

However I did notice, that either it didnt detect my SATA drive. Or it did, but didnt mount it. Oh well, its better than Puppy not booting, like DSL did(nt)

Further information for your question about embedded usb Linux you can find on:
http://www.usb-software.org/wireless_usb.php .
useful resource information for this kind of problem

Both Puppy and DSL embedded lack the ability to access the harddrive. In DSL you can create a virtual HD with instructions in the README file in its folder but Im not sure about Puppy.