Clouston was born in the Birsay parish of Orkney, and educated at Aberdeen Grammar School and the University of Edinburgh. Clouston qualified M.D.(Edinburgh) with a thesis on the nervous system of the lobster, supervised by John Goodsir. His early interest in insanity resulted in an apprenticeship with David Skae, the eminent Superintendent of the Royal Edinburgh Asylum. In 1863, Clouston was appointed superintendent of the Cumberland and Westmoreland Asylum (Garlands Hospital) in Carlisle; and in 1873, in succession to Skae, Superintendent of the Royal Edinburgh Asylum. In 1879, Clouston was appointed successor to Thomas Laycock as Lecturer on Mental Diseases in the University of Edinburgh, a post which he held in conjunction with his position at the Royal Edinburgh Asylum. Clouston became a celebrated lecturer with an international reputation for his exposition of the psychiatric disorders of adolescence. Clouston published extensively, beginning with his remarkable Clinical Lectures on Mental Diseases (1883), followed, much later, by his more popular work Unsoundness of Mind (1911). Another book aimed at the general public was entitled Morals and The Brain; and he remained an unreconstructed believer in "masturbational insanity" and an uncompromising advocate of teetotalism in opposition to his exact contemporary, the psychiatrist James Crichton-Browne. In 1888, Clouston served as President of the Medico-Psychological Association. In 1894 he opened the Craighouse extension to the asylum on Easter Craiglockhart Hill, which was renamed the Thomas Clouston Clinic in 1972. The buildings now form part of Napier University.
Clouston retired in 1908 and was knighted in 1911. He is commemorated by a brass plaque on the eastern aspect of the North Transept of St Magnus Cathedral in Kirkwall. His son was the author Storer Clouston.