Ok, you're doing it wrong, sorry...

Here's what you need to do:

Load a terrain, right click on the terrain and pick "edit object"

Then click on the "reset terrain" button on the left hand side of the terrain editor.

Lower down, you should see an icon for loading a picture, click on that and navigate to your DEM file and load it.

Click OK and you're done, you should see the same as mine.

Injustice will be avenged.
Cofiwch Dryweryn.