How to set password for folder in Windows XP?

Not really (?!?), but have a look to the file properties. If you right-click an excrypted file (from windows explorer) in your folder, choose properties, choose "enhanced" (hope so, I have a german system), chose details for encryption and see, who is allowed to decrypt the file. Normally the creator is a member in this box (may be additionally an admin account, who may be able to recreate the file with a second key). If your account is logged on, can can see and open the file, if you are logged on as another user (not the admin who has recreation rights), you can see the file, but you are not allowed to open it.

You cannot encrypt folders, you can only encrypt the files within that folder.

With the files and folder permission (right-click on a file or folder - security), you can choose the user-account which should be able, to see, open or change your files. These are only attributes added to the file/folder. The file itself is written onto the disk as it is. So, if you get any access to the file (copy to a disk or tape), the file may loose its properties and then everybody can read it. This can happen, if a backup writes the file to a tape without the attributes and the file is restored to another location. Normally, backup software is able to read such files and therefore a system administrator may be able to restore it from the tape. Additionally, a system administrator has the right to take over the ownership for a file and therefore full access.

With the EPS (encrypted file system), you can add additional security.  The file will be changed and you need the same key you used for encryption to read the files. As far as an user with admin right is able to deactivate the file/folder security, nevertheless he needs the encryption key to decrypt the file. He can see it, but can not read it (as far as this admin is not the admin, who has recreation rights).

So it depends on your security needs, if you add encryption to your files, but encryption is usually the second step. Note, that you have a problem, if you loose your key. The (standard) key is created by the system and if you crash your account, it is hard, may be impossible to recover your files!!

Hope this clearifies the way, encryption works.

Another opportunity of course is, to use other file encryption software, but a lot of these programs are as save as the password protection of Winzip. For most of them, you find crack-tools at the internet, others are ok, but you have to pay for them, the windows security is included in your system.