"From what I understand, this option should give me an option to choose existing folders within my server, right?"
Sort of. The process works like this. First you create a file system connection which points to a specific and existing folder in the OS. Then in your Flow you add a Managed Folder using the connection, which creates a folder inside your file system connection. Finally you use the Files in Folder dataset to point it to a Managed Folder and read files from it. Here is how it looks like logically:
File system connection => Managed Folder => Files in Folder
If you want to use an existing OS folder you can follow the same process as above and then inside your new Managed Folder you can create a symlink to your existing folder so it will appear as it is nested inside your new Managed Folder.
