Terrain coloring paints the terrain verts any color you choose.
It is mostly used for adding shadows, lighting 'illusions', and other such details to maps. This feature has a lot to do with the look of the maps in DR2. It can add greatly to the depth and realism of a map, without effecting unit speed or line-of-sight the way textures and geometry do.
There are two colored rectangles in the menu. The top one represents the color that will be applied if you left-click. The bottom, if you Lshift+ Lclick (you can set two different colors for convenience).
Click one of the boxes to change a color. Adjust the sliders to get the desired color, or type the RGB values into the adjacent boxes. Left-click the terrain to paint the terrain verts that color.
You can further tweak how the color is applied with Circle Gradient, Circle Sharp, Circle Negative, and Irregular brushes. The slider just below these brushes represents the "pressure" at which the color is applied.
You may find it helpful to load some of the single player missions in the editor and see how our artists used terrain coloring.