Smith will enter Saturday eight strokes behind leader, fellow Australian and his LIV Golf teammate Lucas Herbert.
Following a blistering start on Friday, the former world No.2 slumped down the leaderboard to a tie for 18th after imploding on the back nine at Kingston Heath.
But Smith says all is not lost, particularly given a forecast of rain on Melbourne's sandbelt.
The 2022 British Open champion believes he is still playing well enough to challenge.
"I'm playing really good golf. It was just kind of a shocking nine holes and a couple of mental errors where I felt like I was running around there a little bit," he said.
"There's still a lot of golf to be played and that's the way we've got to look at it.
"And be aggressive out there but also be quite patient because there is a lot of birdies out there so I don't need to do anything different."
Smith began well but came unstuck with a horror back nine on Friday. (Con Chronis/AAP PHOTOS)
While Smith struggled on Friday, golf's new golden boy Elvis Smylie sparkled while surged up the leaderboard.
The winner of last week's Australian PGA Championship carded a sublime 64 to rocket into a share for third at nine under.
Smylie had been three over through seven holes on Thursday, but has since amassed 13 birdies to roar back into contention to complete a rare summer double of twin victories at Australia's two flagship tournaments.
The 22-year-old Smylie said he felt rested after a huge campaign and ready for a weekend assault.
"I've wanted to keep working and keep working and keep practising, but the people that I have around me are doing a really good job with just keeping me in line," the Queenslander said.
"I'm actually feeling really fresh now and I'm ready to attack the weekend.
"My game is good enough to win, so I'm obviously doing a lot of good stuff at the moment.
"It's just focusing on the little stuff and doing that well, and good results are a by-product of doing all the one-per-cent stuff well."
Hyojin Yang is a surprise halfway leader in the women's division. (Con Chronis/AAP PHOTOS)
The stage is also set for a thrilling finish to the women's Open.
Teenage amateur Hyojin Yang is the shock halfway leader at nine under.
But the 17-year-old has fellow South Korean, former world No.1 and 2013 champion Jiyai Shin and home hopes Justice Bosio and Hannah Green breathing down her neck.
Shin and Bosio are just one stroke behind, with Green two back and looking ominously ready to pounce and crown her stellar 2024 with a fourth title - and cherished maiden Open crown.
"I've put myself in a good position for the weekend, so hopefully Kingston Heath, we don't get too much rain," said the world No.6.
"Honestly, I've heard mixed forecasts. I've heard there's going to be a little bit of rain, I've heard a lot of rain.
"So it really depends on that.
"But I think Kingston is already soft and so that will help us women to make lots of birdies."
With an uncertain forecast, officials will use two starting tees for the third round.
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