Create a new document in Photoshop with square dimensions, say 800 x 800 pixels, RGB or Greyscale colorspace is acceptable, you'll do all your work in shades of grey. Remember that dark areas represent low terrain and light colors high terrain.

Do a color fill with a dark grey and then apply the Clouds filter over that using a dark grey/light grey combo. Save it as a PSD, then create a new document in your 3d app, add a terrain object, use the import feature apply your photoshop image to the terrain and you're ready to render!

To obtain a softer look try applying some gaussian blur to your Photoshop file, some nice rolling/choppy water effects can be achieved with that method.

Another thing you should play around with is import any other picture into the terrain editor just to see what happens. Mess around, do a few tweaks and you could have a really unique masterpiece to show off!

If you'd like to play around with the cloud images feel free to download them!