Rosie, I think your question is only being partially understood and answered.  You figured out to grab the bracket to crop top and bottom but you asked what is happening when you drag the gradient itself. Correct?   

I don't know either.  It changes some things weirdly in the terrain preview but seems to have done nothing when  backing out of the terrain editor to view the real results.  Can someone tell us what is happening or not happening.  

The rainbow thing will select pretty colors on the resulting terrain but why and how would that ever be used unless you were just doing crazy color for giggles.  Is there a legit purpose for that feature?