You can do it that way but you must only loop (select) three vertices, or you will receive the same message as is displayed here. There is a menu option that will create a face using the selected verts in Milkshape.
I would have sworn that this was the cause of the problem based on the screen shot. Just be careful to not create more than a single vertice (click) at a point or you will have this problem.
I create my faces the same way, by selecting the verts one by one with the face button selected.
Making nothing for the forth straight year; or is it five years now?