How much free space should I defrag?

Free hard disk space
Drives without any free disk space cannot be defragmented. For the best possible results, at least 5% of the whole hard disk capacity should be free. Files larger than the maximum free and connected storage space, may not be possible to defragment, and if so only with several runs.

Meaning, there should be more enough space on the hard drive and avoid keeping larger files?

It does not mean you will avoid. Though it is better to delete unused files or save it in your USB so the extra space would be good in defragging your computer.