Not quite.
You need to open iTunes, go to any song you want to make into a ringtone, right-click it and "get info". Go to the "options" tab, and make sure that the "stop time" is no longer than 40 seconds.
Now go back to the library screen, and right-click the song again. Click on "Create AAC version". Now find the newly made AAC version in your iTunes Music folder (usually c:\documents and settings\[username]\my documents\my music\iTunes...). Rename the file from <songname>.m4a to <songname>.m4r. Now double click it so that iTunes opens the file, it will add it to the ringtones folder.
Now remove the duplicate you created before from your main library, job done.
Nice, I will give this a try. Thanks.