By the sound of it, you have what is usually known as a "Finger Clock" (Often referred to as a "Verdict", one of the other main manufacturers of this type of device).
This "tenths" type of clock has a limited range of movement. It is intended to be used to measure small differences. As you correctly say, there should be a small preload. Most finger clocks have a range of about 0.020" or 0.040", so the preload should be about 0.005 – 0.010", because these are the sort of eccentricities or height differences that you should be expecting to measure.
In your case the stylus is coming clear of the work, because the eccentricity exceeds the range of movement of the clock.
Finger clocks can be obtained which measure in 0.001" increments.
Firstly, presumably, you wish to centralise the work on the Rotary table?
1)Set the clock so that it cannot move relative to the Rotary table. (A Magnetic base will make this much easier.)
2)Move the clock to give a small preload and adjust the Rim to bring the Zero to the Needle.
3)Rotate the Rotary Table until a maximun reading is obtained. If the stylus comes clear of the work, move the workpiece on the Rotary table by HALF the apparent error.
4)Reset and reZero.
5)Rotate the Rotary Table and remeasure the eccentricity.
6)At the point of maximum reading, move the workpiece by HALF the eccentricity,
(You may well need to do this in both planes).
7)Repeat these operations until the workpiece is centred on the Rotary Table to within an acceptable run out.
8) Ensure that the workpiece is firmly secured to the Rotary Table, and recheck that the workpiece is acceptably central. (Your decision as to whether within 0.0001" or 0.001" unless the drawing specifies the tolerance)
Once the work is set centrally on the Rotary table, you can begin to set the Rotary Table under the Spindle of the Mill.
1) Fix the clock to the head of the Mill and proceed as below.
You need to move the work piece, (Held on a Rotary Table on the Table of the Milling Machine) by moving the Table to reduce the amount by which the stylus fails to contact the work.
Again, this will need to be done in BOTH planes (X axis – along the table, Y axis to and from the column)
2)Reset the DTI to a small preload, and and adjust the outer rim to read Zero .
3)Rotate the Rotary Table, until a maximum reading is obtained.
4) Move the Table of the Mill to reduce the reading to HALF of the original value.
5) Repeat steps 1 to 3 until the DTI shows an eccentricity ("run out"
which is acceptable to you.
6) Lock the Table on BOTH axes.
You are now ready to bore the hole to the finished size. Hopefully, the eccentricity of the already drilled hole is less than the depth of cut need to bring to finished size. If you are using a Boring Head, my advice is to take small cuts, and to take "spring cuts", (without altering anything), regularly, checking size after every cut. You may be surprised how much material is removed on a spring cut.
If you are reaming, check the run out of the reamer, when fitted to the Spindle.
A spindle which runs eccentric (not unknown) or a bent reamer will result in an oversize hole.
(Which is why, if possible, you bore or ream first, and then turn the male component to give the required fit.)
Sorry to go on at such length, but taking short cuts (PUN not intended) is likely to help fill the scrap bin rather than deliver a part to the required size and surface finish.
Hope that all this is of some help.
Remember the old adage "Measure twice, cut once" Wish that I did that regularly!
Howard