Yes, you just choose your ringtone on settings, sounds, ringtone than select the one you want.. But i don`t know how to choose a music track and make that your ringtone.
Before, i always bought ringtones from iTunes store, but later, I switched to iPhone Ringtone Maker for Mac. Well, if you are a Mac user, you can have a try. More is available at the related links...
Generally, ringtones are for iPhones, but on the iPod Touch, they are used for Alarms. This is only for the default App, 'Clock' which is already installed on your iPod when you buy it.