I guess you should mention some prerequisites for installing your way!
Guess this can be done only from XP onward OS?

If you mount the ISO on a virtual drive you'd get the same install as this, without the need for an extra partition.

Also true.. you cannot use this method if you are coming from 32bit xp, and looking to move to 64bit Win7. I get the error, 'setup.exe is not a valid win32 application'.

Priceless.. it WORKED :P
I had a split partition ,4 y old laptop running XP with a busted dvd drive and not a usb boot option. Props to windows for making this so easy.. just mounted my iso with D-tools.. copyed it to my partition not running windows and opened setup.exe . (had FAT32 on c: drive so i had to change to NTFS)
Choose to fully install (not upgrade) and it went great.
Best guide EVER

Install Windows 7 TO external drive?

i think there is another method in installing windows without any external devices(for those coming from 32 and moving to x64) by creating a partition, copy the content of the iso file to the new partition and mark it as active, then reboot..i tried it on vista but not tried in win7..could someone confirm?

1. Use a free program like ImgBurn to extract the downloaded ISO to a partition or drive on which you are not going to Install Windows 7.
2. Make sure you have around 16GB of free space on the partition you wish to install Windows 7.
3. Go to the folder where the ISO is extracted.
4. Run Setup.exe and Follow the instructions.
   
   1. Choose where to install Windows!? (Refer to step 1.)
5. The installation Runs Like Usual.
6. If you installed windows on a partition where another version of windows was already installed, Just Delete the Windows.Old folder by using Disk Cleanup.
7. You have a new build of Windows.

WTF? You run setup.exe from a partition or drive you have no intention of installing Windows 7 on and them BAM, like magic, Windows 7 just installs to the drive/partition you want without ever being told to?

BIG HOLE in instructions...