How would Find my iPod work on a locked iPod Touch?

I'm afraid you're completely right. Apple does even make a statement on its website about it:

However, there are some alternatives.
But since there is no way to come up with a work around on this problem, 3rd party software, like Undercover allows you to store the latest locations of an iDevice. Where Find my iPod touch will only show you the current location (it doesn't show a history of locations I think), Undercover will save its latest location, as they say on their FAQ page:

What happens if Undercover is launched when a phone is not connected to the net? Will it still transmit its location?

If Undercover is launched on an offline device (no 3G or Wi-Fi), its location is saved. As soon as the device goes online and Undercover is launched again, saved locations will be transmitted.

It worked for me in my school, someone stoled a friends iPod touch and with my iPhone we located and make it sound very loud, after a few minutes the iPod appeared in the principals office, that was an awesome thing! Another idea is if you turned on share 3G network with the IPod touch it will connect automatically when you are close to it and it will share the position to you! I know this could look like an useless function for the ipod touch but it worked perfectly for me and my friend got back his iPod! Very nice thing from apple.