Don't understand set height tool

I've been trying to follow the T3D construction series and I've discovered that I have absolutely no clue about the set height tool in the terrain editor. I follow the steps in video 1 exactly as they do them and my set height does not act like the one in the video.

What exactly is this tool basing the "set height" off of? The video sets the options to 500 to make an oasis. However 500 for me makes a hole about a million miles deep. It seems no matter what I set it at, I get the same size hole with an editor generated terrain (1024, sand texture, flat). It seems to base this off of some point far below my terrain top.

So, I then just brought up the blank terrain ( I am using an unmodified version of the full template by the way). I set height to 500 and get a tower of land rising up to the sky. I set height 50 and get a relatively deep indention not too bad for a lake. I set my height to 1 and get a deep hole. this is acting completely different than the video. Do I need to have my terrain at a certain position to get this tool to act like the one in the video?

Thanks!