Sometimes if you make the Heightmap 'yourself', it refuses to work.
Usually, I take the watermill heightmap, edit it, and save it as another file. However, if I make my own or edit a heightmap that was not orginally Watermill, it doesn't work!
Try copy-pasting your image into 'watermillterrain.jpg', then saving it as another file.
Of course, make sure it's the usual 'Grayscale, 513x513, etc. .'