Is it a grayscale terrain?
All terrains must be grayscale, to they will not work. GIMP is a good terrain maker, in which I use. I hope this helped, if not check the Maps section of the forum and look at the help area. Also, picture must be PNG or JPEG. And extra layers. And it must be in the Watermill folder, plus, you need to have made it on a base of the same size any other Height Map is. =) <3
~Hallucination