(1) This smells like rotting fish.
(2) This smells like rotten fish.

I think both participles are correct here. Perhaps it's a question of just how far along the process of rotting is? Dictionaries don't help much, and I can't seem to find a "rule". I know that this is not true of all adjectives. How to explain to a student?
Original Post
I think you've described the difference between the two adjective forms just right, my friend.

The present participle descibes a process active at the time of the sentence, in this case the present.

The past participle adjective describes the noun when the process is basically over.

Here's another pair that demonstrates what I mean:

  • She poured the boiling water over the tea leaves in the pot to brew them.
  • The boiled water and tea leaves were left to steep in the pot for a few minutes.
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