1. THX is for all theatrical sound tracks. Without better processing (Lexicon Logic 7) it's a good choice.
2. You want to set your DVD player to "DTS"
1. High frequencies are attenuated in a theatrical playback environment - perforated screens attenuate high frequencies and it's a big space with lots of high frequency absorbtion (people, seat cushions, etc.)
Low frequencies are lost too - the main channels don't go below 40 or 50Hz.
All theatrical sound tracks need to sound right in this environment and the same in different theaters. The theaters are equalized to sound the same with their playback systems having the X-curve response rolling off 3dB/octave above 2KHz and below 63Hz. The high frequencies are boosted to compensate. The playback systems lack the excursion to handle low frequency boost so those are ignored.
When you play such a sound track back on a system with flat response it's horribly bright (+3dB @ 4KHz gets you lots of siblance, +6dB @ 8KHz makes metalic sounds shrill) and you hear extraneous sounds (hums, thumps, etc) that were missed in the mixing process.
This is more common on older DVDs.
THX mode provides a re-equalization option to compensate for this which may be available in other modes as Re-Eq.
Theaters have a diffuse sound from banks of surround speakers far from the listeners and high above their heads. While there may be 1-3 discrete surround channels each one is still diffuse.
THX dipole surrounds keep the sound diffuse on each side.
The THX mode provides decorrelation for in-phase signals so you still have a diffuse sound for all monural surround signals whether from Dolby Surround with its single surround channel, Dolby Digital EX, DTS 6.1, etc.
This may also be available in other modes (Lexicon's Logic-7 always does this)
2. Digital equipment varies in its processing capabilities - you may have pro-logic decoding only which requires a 2-channel input, that plus Dolby Digital, or that plus DTS.
With PCM your DVD player will down-mix Dolby Digital to 2 channels with an optional Dolby Surround encoding and pass (very rare) PCM tracks.
With bitstream it will pass Dolby Digital and PCM unchanged but not output DTS at all.
With DTS it will output anything recorded on the DVD.
