I would like to know in more detail what this file does and why does its size keep increasing. Also what is its relation to RAM. I tried searching about this but didnt find much information. Perhaps you guys can help me... Thanx

Here's a good explaination i found :
The Win386.swp is the Windows swap file used for Virtual Memory in the Windows environment. This allows the computer to provide more memory to applications than is physically present in the form of RAM.

This file can grow very large in size and needs to space to grow. Hard disk drives with low available disk space will experience issues and decreased performance because of the lack of space available for this file to grow.  

Answers:

The following is a listing of questions and answers to those questions relating to the Windows Win386.swp file.

How can I change the Win386.swp file location?

It may be necessary and/or recommended that users with different partitions or hard disk drives store the win386.swp on a different hard disk drive. Reasons why this may be beneficiary.

If little or no space is available on the drive where win386.swp is located moving the swap file will help save space on that location.
If a faster hard disk drive is installed onto the computer, moving the swap file location may help in increasing the performance of the computer.
How to move the swap file location in Windows 9x and Windows ME:

Click Start / Settings / Control Panel and double click the System icon.
In System Properties click the performance tab.
Click the Virtual Memory button.
Select the option "Let me specify my own virtual memory settings.
Specify the hard disk drive where you wish for the win386.swp file to reside.
After setting custom virtual memory size, file changes from C:\<windowsdirectory> to the root of C:\ drive.

This behavior is by design to help inform any individual examining the computer that a custom virtual memory setting has been selected.

After deleting the Win386.swp file it re-appears.

Windows Swap file is created by Windows and if it happens to be removed, Windows should recreate the file unless it has been disabled.

When storing the Win386.swp file on a removable media device and attempting to eject the storage medium from that device errors occur or the computer freezes.

Because the Windows Swap file is almost always being used ejecting the device or removing the device storing this file will cause errors as it will remove the location of where information is temporarily being stored.

When booting from a removable media the performance tab may show that the computer is running in MS-DOS compatibility mode.

Change the location of the win386.swp file to a non-removable media.

Is the Win386.swp a computer virus?

While it is not impossible for a virus to be within the Win386.swp file it is very unlikely that you have a virus on the computer.

There are several users or so-called 'hackers' who claim that they have infected your computer with the Win386.swp virus. This file is not a virus however to some users it may appear to be a virus as the file grows very large in size as well as well re-appear after deleting the file.

If an individual has claimed to have sent you a virus through a chat channel, however you have not downloaded or accepted any files it is very unlikely that you have a virus and that they are just trying to scare your or cause you to believe that they are a hacker.
To educate yourself more on the topic Computer Viruses it is recommended you review our Computer Virus section.

Thanx for a detailed description.
My problem:
my hd is only 3 GB so i wanted to know if the space this file is taking up is really necesary or not.
I want to know what 'Let me manage my own virtual memory settings' does, and can it make its filesize smaller. I havent tried it myself since i am not sure if it is safe.

How much RAM have you got?

I had 32MB but the day b4 yesterday i upgraded it to 96MB

Here's a good article on controlling the size of your swap file:

http://www.cyberiapc.com/vm.htm

thanx. that explained it clearly
I'll set the virtual mem now according 2 my new memory.
do u think the scandisk/defrag problem i had (and still have) has got anything to with it?? thanx again

Scandisk/defrag shouldnt have anything to do with it ( but we are talking about microsoft so who knows)  scandisk can repair just about anything(so they say) but defrag doesnt defragment your swap file (win386.swp) the only way to defragment this area is by first disabling virtual memory (but pray your pc will start again afterwards) then running defrag.  i doubt these r causing the problem.

I have moved this into the new FAQs and Tips section as this has very useful information.