Hi Mike
If I understand, you want to detect as little as a 1mm drop in level due to evaporation? And your sensor is being read by an Arduino which is doing ADC to capture the data?
Couple of thoughts. If typically the 1mm of evaporation takes much longer than the 2 second period of a 0.5 Hz wave, maybe the Arduino could take many readings over a longer period and average them, taking the median value?
Or you could use the Arduino to capture raw data, transfer the data onto a PC (or a cloud-based service like plot.ly) and then use "best fit" type software tools to plot the water level from the noisy data.
Alternatively, maybe there is a way to add mechanical damping to your sensor.
Regards
Ray