I have more than 160 gb of content!

This sounds silly to me and will to you also. I have more than 160 gb of media. Does ATV have some sort of preferential treatment of the media? If it keeps most played It will not have my current newly added movie. Just trying to figure out why I would want a 160 when a 40 could suffice.

appleTV cannot connect directly to an external drive, everything must still go through iTunes.
i.e. either put your entire iTunes Library on the external and then point iTunes there (iTunes > Preference > Advanced) or you can also put some portion of your iTunes Library on the drive. i put my movies on a large external and my music on an internal drive. most people don't realize that files don't have to be in your iTunes Folder to be in iTunes. the trick is to click and hold the option key as you drag items into iTunes. this places a reference to the location of the file in iTunes rather than copying the file into the iTunes folder. in this way you can have your files anywhere you'd like. or if you wanted the whole library on an external you can just copy everything there and go to iTunes > Preference > advanced and move the location of the iTunes Library to the external drive.
i have my iTunes library "linked" to the appleTV so it is a syncing library (i.e. not "shared" which is a streaming only library). in iTunes i use a custom sync and basically i turn off all syncing from the media tabs except for photos. in the summary tab i uncheck the "show only synced item on appleTV" option and this lets me see the unsynced content but when i click on it on the appleTV it gets streamed. having it as a syncing library means that content bough on the appleTV gets synced back to my iTUnes library where it can be backed up on another large external drive via time machine. that's the other thing that you need to think about too is that you need to back up all this expensive stuff... on hard drive failure and poof, all your stuff could be gone... not just the appleTV other stuff but stuff on your computer that you might not be able to replace... a 1TB drive is less than $100 the last time i checked there is no reason not to back up.. can you really afford to have all your media, photos etc go up in smoke.. all hard drives fail eventually.. you just can never predict when.. back up!

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