A knee effusion is excessive joint fluid inside the knee joint.

An acute knee effusion is one that comes on suddenly. A chronic effusion is one which is there all the time. It is an indication of an underlying problem in the knee, such as a torn meniscus, torn anterior cruciate ligament, gout or arthritis.

Side view of the knee, showing a swollen capsule, tense with a joint effusion. The joint capsule is watertight, and since the fluid of an effusion is secreted by the cells of the inner lining, the swelling can become quite tense.
What is water on the knee?
Patients often describe an effusion as 'water on the knee', but the fluid is not actually water and it is not 'on the knee' but contained within the capsule of the knee. The fluid of an effusion is secreted by the cells of the 'synovium' which form the inner lining of the capsule of the knee joint, and will differ depending upon the trigger. The fluid is usually viscous and slightly yellow, and contains white blood cells and other cells commonly seen in inflammations. In certain conditions there may be crystals within the fluid.
Will fluid on the knee go away on its own?
This is an active system, and fluid can also be resorbed back into the blood. If there is something in the joint triggering inflammation or irritation, then the rate of secretion will exceed the rate at which the fluid is resorbed, and that determines how persistent is the effusion.
CLINICAL PUBLICATIONS
Clinical assessment of effusion in knee osteoarthritis—A systematic review. Maricar N, Callaghan MJ, Parkes MJ, Felson DT and O׳Neill TW. Semin Arthritis Rheum. 2016 Apr; 45(5): 556–563.
Quadriceps Activation Failure After Anterior Cruciate Ligament Rupture Is Not Mediated by Knee Joint Effusion. Lynch AD, Logerstedt DS, Axe MJ and Snyder-Mackler L. J Orthop Sports Phys Ther. 2012 Jun; 42(6): 502–510.
Acute Knee Effusions: A Systematic Approach to Diagnosis. Johnson MJ. Am Fam Physician. 2000 Apr 15;61(8):2391-2400.