The receiving was especially strong from Wang Qiang as she won 57% of her receiving points which allowed her to break her opponent's serve on 5 occasions.
In the tense final set, both players held firm but Wang pounced when Williams was serving to stay in it, converting her third match point as the American netted.
It was Williams' earliest exit from the year's first Grand Slam since 2006, when her title defence was ended by Daniela Hantuchova.
"I definitely do believe (I can equal it) or I wouldn't be on tour", said Williams, a seven-time victor at Melbourne Park. It allows me to go quicker through my games and win more dominantly my service games and put additional pressure on the service games of my opponents.
"I went through a couple of things, more than in NY honestly", Nadal, a four-times U.S. Open champion, said when asked about his relatively lean Australian Open record.
"In the third, I was more relaxed, more aggressive and found better play in that set", he added.
"It's not even about the slams, it's about just me playing good tennis, and I didn't do that today".
"I'm way too old to play like this at this stage of my career", she explained.
Wang, the 27th seed, was walloped 6-1, 6-0 by Williams in last year's US Open quarter-finals, triggering a torrent of criticism from Chinese fans at the manner of the defeat.
And the holder of 16 titles in the major tournaments, in the next round, meets a second Japanese player, Yoshihito Nishioka, who beat Britain's Dan Evans in three sets 6-4, 6-3, 6-4.
German seventh seed Alexander Zverev moved into the third round for the fourth straight year with a 7-6 (5) 6-4 7-5 victory over Egor Gerasimov.
"Probably after 15 years, she doesn't care much".
The Dane announced last month that the scene of her greatest triumph, when she broke her grand slam duck in 2018, would also be the stage for her professional farewell at the age of 29.
"I think I can do lot of things better".
It was Djokovic's 70th match win at Melbourne Park to only eight defeats, but one of those defeats was against a wildcard - Denis Istomin - in the second round three years ago.