Sure. Most virtual machine tools work with disk images, not actual disks, and they'll let you create an image for the Win98 VM anywhere you want. I've run VMs off pendrives, and even off network shares over WiFi.
(For the same reason, I'm guessing you don't actually need the external hard drive, since there's no need to create partitions, and the disk images can grow on demand, so the entire Win98 VM might be a tiny ~500 MB .vdi or .vmdk file. Moving it to an external HD wouldn't give you many advantages.)
Though, if you for some reason want to assign a real disk to the VM, that's often possible as well, though usually hidden under "advanced mode" or even command-line tools. For example, in VirtualBox, you need to create a special "redirect" image for that.