Creating a realistic water surface in Photoshop is quite a challenge because it is the distorted reflection of the surroundings that makes the water look liquid. The displace filter is an excellent tool for making this distortion.
The displace filter “shifts pixels” in an image according to the brightness values of a displacement map.
You can use any .psd file as a displacement map (if saved with “Maximize compatibility”). Displace uses the first and the second channels of this .psd file for horizontal and vertical displacement respectively. Each channel is a grayscale image. Medium gray (brightness 128) does nothing. Darker values will shift an image in the positive direction (in Adobe coordinates). Brighter values cause a shift in the negative direction. The amount of displacement can be controlled separately.