I get where you're coming from. I've been considering something like this for a while, but couldn't quite decide how to implement it. MobESP's tracers have the same problem, except there, the unwanted tracers most often lead to caves.
A range limit is certainly one way to address this, but has the drawback of a) never showing far away entities, even if there are only a few of them, and b) the tracers within range might still go into caves.
Another way could be to limit the number of tracers, so for example only the closest 10 entities would get tracers. That way, you don't get too many tracers when you're in a crowd, but when you're all alone and a player starts to sneak up on you, you would still see the tracer immediately.
Ideally I would also want some kind of cave filter. Mostly for MobESP, but it could also be useful in some minigames with a lot of verticality. A simple vertical range slider would do the trick, but that would also hide entities that are on mountains or towers, where they could snipe you, so having that tracer visible would be important.
What if the vertical range only affects entities below you? That works reasonably well as long as you're on the surface, but it breaks when you're in a cave too. When the player enters a cave, such a filter should probably either turn itself off, or switch to hiding entities on the surface.
Overall, there's a lot to consider here, plus the solution needs to be intuitive and all those settings need to have relatively simple names. Let me know what you think and if you have any ideas.