Outside of it, as in, not inside it.
Any directory *NOT WITHIN* your install directory.
If your install directory is c:\games\Homecoming, then the data directory you are using to build your mod CAN NOT be within that directory.
The idea here is to make 100% sure you are not including anything other than what you want in the archive. If you have anything else in your data directory, and you point it at that directory it's going to package everything. You can test your mod as usual via the data directory in your install, but to actually package it and distribute it you need to make a clear folder structure with JUST your files elsewhere.