The 50-year-old Pooley birdied the 77th hole of the championship to become the sixth player to win the event in his maiden appearance. He also became the first qualifier to win the tournament.
The two finished regulation at 10-under-par 274 to enter a three-hole cumulative playoff ' the first such playoff in Open history.
Both men parred each of the three extra holes to force sudden death. They then matched birdies on the fourth extra hole. Pooley ended the suspense with his second straight birdie one hole later.
The victory was Pooley's first in a PGA Tour-sanctioned event since his triumph in the 1987 Memorial Tournament.
'This is my first win on the Senior Tour, and to win the best tournament on the tour, it's just huge,' said Pooley. 'I mean, it's amazing.'
Pooley won twice on the PGA Tour, creating a David vs. Goliath scenario Sunday against the eight-time major champion Watson.
The two combatants started the additional session with 4s on the par-4 16th. Both men missed the fairway and the green. Watson rolled home his eight-footer for par, while Pooley did the same from six feet.
They again posted pars at the par-4 17th, with Watson two-putting after playing his tee ball into a fairway bunker, and Pooley getting up and down from 40 yards.
Pooley finally hit a fairway at the par-4 18th, and took advantage of his accuracy by knocking his approach shot to seven feet. Watson, however, found another fairway bunker and was forced to try and save par from 50-plus feet.
Watson lagged his first putt 12 feet short of the hole, but made the save to force Pooley to putt out to win.
He missed on the low side.
For the third time Sunday, the two played the uphill, 455-yard 18th. Pooley hit his second shot 15 feet left of the hole; Watson stuck his to 12 feet on the opposite side.
Pooley made his birdie effort - his first birdie in 18 holes, returning the pressure to Watson's shoulders.
He responded, drilling his putt dead-center.
Again they played the 18th. Watson's approach flew the green and landed in the deep rough. He pitched out to seven feet, but it proved irrelevant, as Pooley, after backing away once, made his 12-footer to earn the $450,000 first-place prize.
'I thought I was having a heart attack out there,' he joked.
Watson earned his fourth runner-up finish in his last 10 starts.
'I'm finishing second way too many times,' he said. 'I feel like Phil Mickelson to Tiger Woods. It's not a lot of fun to finish second.'
The playoff was the fifth in Senior Open history, and the first since Jack Nicklaus defeated Chi Chi Rodriguez in an 18-hole Monday endeavor in 1991.
Pooley almost didn't make this week's field. He was one of 116 players vying for five qualifying spots. He birdied the final hole to enter a playoff, and then birdied the first playoff hole to punch his ticket.
Pooley, who shot a tournament-record 63 in round 3, began the day with a three-stroke lead and birdied the first and third holes. Watson matched the birdie at 3, but still found his deficit increasing as the remaining holes were decreasing.
Pooley maintained a four-shot advantage entering the back nine, with Watson, Tom Kite (68) and Ed Dougherty (70) all tied for second.
The latter two were unable to challenge coming home, but Watson was a different story.
He stuffed his approach shot at the 10th inside of three feet. And despite a putting stroke that would have made Billy Mayfair cringe, he sliced in the birdie to move within three of the lead.
Throughout the week, only Watsons flatstick had kept him from running away with the title. He led the field in greens hit in regulation and was tied for second in driving accuracy. However, he was tied for 30th in putting.
Nonetheless, the putter proved to be his biggest asset en route to forcing the extra session.
Watson rolled in a seven-footer at the 13th to get within one, and then holed a 20-foot curler at 15 to tie Pooley at 10-under.
While Watson continued to split fairways, hit greens and make putts, Pooleys nerves started to show.
He pulled a metal wood on the 227-yard, par-3 15th, but got a reprieve when his ball caromed off the embankment onto the green. He two-putted for par, only to find the right rough off the tee at 16.
With the ball well above his feet, Pooley slapped his second shot out of the weeds, through the fairway and onto the green.
Watson was only 119 yards out, but missed the green with his pitching wedge. His pitch third shot then checked up 15 feet short of the hole, from where he failed to get down.
Pooley, on the other hand, two-putted for par to reclaim sole possession of the lead, and then scrambled for another save at 17.
Watson continued to apply the pressure, sticking his approach shot at the penultimate hole to 10 feet, and coaxing in the delicate downhiller.
Tied at 10-under, both men were neck and neck off the tee at 18. Pooley hit first, pushing his approach into the right bunker. Watson followed suit by hitting his second shot 35 feet beyond the hole.
Pooley blasted out to 2 feet, the same distance to where Watson lagged his birdie effort.
Both made their putts to force the three-hole playoff.
Full-field scores from the U.S. Senior Open