What is a disk image??

Hello,
I've just backed up my Mac, onto an external hard disk. I've now begun to think that I should make it secure, so if it ever fell into the wrong hands they can't access it without a password.
I understand that I have to create a 'Disk Image'. But what is a Disk Image? Is it simply a folder with my backup in, which is protected by a password?
I've opened Disk Utility, gone to File > New > Disk Image from Folder > selected my backup folder on the external hard disk > selected encription > and saved. It is now taking an age to make a Disk Image (whatever that is).
Once it has finished, do I treat it like a normal folder? Does it move the original backup into the Disk Image, or should I delete this? How do I use it?
Thanks

Thanks for response.
I want to backup my entire computer onto an external hard disk. I've done as you said: made a Disk Image of my Hard Disk (password protected, read/write). I can now copy that to my external hard disk.
I now intend to backup my Users > Home folder every week. But I can't drag my Home folder onto the .dmg file to copy and replace the old Home folder.
Does this mean that I have to double click the .dmg file, to get the disk icon to appear on my desktop. I then drag my Home folder to this folder to copy and replace the old Home folder. And amazingly this links to and updates the .dmg file.
Won't this take ages? The .dmg file has to open (process 1), the file has to copy and replace the old Home folder (process 2) and then somehow the disk icon on the desktop has to link back to the .dmg file (process 3)
Can I not just password protect the entire external hard disk or password protect a folder?
Thanks

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