I'll try and answer your questions...
Bitstreaming is where your player will send the "bits" of an audio stream to the receiver so it can decode it. Most every receiver can do Dolby Digital, DTS, and some of the variants, but only newer receivers can decode the hi-def codecs like Dolby True-HD and DTS-MA.
PCM is Pulse Code Modulation. There's lots to read about it, but what you need to know is that your player is doing the decoding and sending the audio via 5.1 over your connection, so your receiver just regurgitates this, it doesn't do any decoding. Most Blu-Ray players and 99% HD-DVD players can decode everything and push PCM to a receiver.
It doesn't look like your Denon will decode the newer codecs, so set everything to PCM.
I think you want to hook your cable box and your PS3 into your Denon, and then out to the LCD. I think the PS3 does PCM output, so maybe that's why your Dolby light doesn't come on (your receiver isn't decoding anything). Hope this all helps!