Shaking off a rough day on a course that rediscovered its signature windy 'whistle,' Watson shot a 1-over-par 73 to take a three-stroke lead over Loren Roberts going into the final round on Sunday.
John Ross, Sam Torrance and Vicente Fernandez are tied at 3 under.
Players had to contend with winds that blew at an estimated 10-20 mph and got stronger later in the day. Only eight players played the course under par Saturday. Even harder winds were forecast for Sunday's final round.
One of the few players to make a major move up the leaderboard was Senior PGA tournament champion Denis Watson, who began play at 3 over for the tournament but had the best round of the day, a 5-under 67 to move to 2 under overall.
Tom Watson began the day at 8 under, but his three-stroke lead began to vanish when he missed an 8-foot putt for par on the first hole. Watson birdied the fifth hole, but bogeyed Nos. 8 and 9 to leave the front nine in a tie with Roberts at 5 under.
Watson birdied the 10th as Roberts made bogey, but Roberts birdied the 11th and caught Watson to tie for the lead again on the par-4 14th. Roberts sank a long birdie putt, then watched as Watson missed his own 6-foot putt for birdie.
Roberts hit his second shot on the par-5 16th into the rough. He recovered to make par, but Watson made a 15-foot birdie putt to retake the lead at 7 under.
Roberts' tee shot on the par-3 17th plugged deep in a bunker, forcing him to take a drop for an unplayable lie. Roberts two-putted for a double bogey, and Watson had his three-shot lead back.
For all his success in major tournaments in his days on the PGA Tour, Watson has never won a U.S. Senior Open. He has had several chances, finishing second in three of the past five.
Playing with the lead in front of a partisan crowd in his home state of Kansas in the final round of last year's senior open, Watson was beaten by Allen Doyle.
But Watson didn't win five British Opens without knowing how to play in the wind, a skill that came into play on Saturday and might be even more important with 25 mph winds expected Sunday. High winds are supposed to be the signature of Whistling Straits, which sits on the coast of Lake Michigan and looks more like a potential British Open site than a slice of central Wisconsin.
The wind whistled hard during practice rounds earlier this week but vanished for the tournament's first two rounds, leading to unexpectedly low scores.