A good fighter is like water, while a bad fighter is like a rock. Being like water can mean many different things while fighting. Understand all three and you will be a better fighter.
My master says that being like water is to fill the cracks of your opponent. Water goes into the lowest cracks and fills them up before another part. Attack your opponent were s/he isn't blocking, boxer/street fighters you should go for the legs or if someone has a weak arms your best chance is to attack to that side, etc. Study your opponent, don't just blindly attack him, look for areas that s/he doesn't cover, or weak body parts, or repetitive moves, these are the cracks you must fill.
Some say to be like water is to absorb the strikes and fill it back in. If you punch into water it absorbs your hit and then fills in where it was hit. If someone kicks your thigh (roundhouse to the thigh is very effective to bring the average or sometimes bigger fighter down) you mustn't drop down and cover it you have to stay strong and protect it better, ignore the pain, pain is just a feeling and feelings can be diverted like mad->sad, but instead pain->pleasure, make yourself enjoy getting punched in gut or kicked to the leg, and absorb the strike and fill in the mark that it left.
It can also mean to take shape of the situation and shape into the form. If you ever watch UFC then you know what I mean, you have to be good at stand up fighting along with ground fighting. If a tae kwon do expert is beating the shit out of a jujitsu fighter but all of a sudden he takes the TKD fighter down then whats he going to do? TKD doesn't teach ground fighting but jujitsu is basically all ground fighting. The TKD fighter has just lost even tho he was winning, the only way to prevent this is to predict that its going to happen someday so train for it. Expect to be taken down, train for it, adept to your surrounding and your situation. If you are fighting against someone and they take you down you better know what to do and "form" into to a ground fighter, and when you get back up you "form" back into a stand-up fighter.