The 33-year-old -- whose long-time team-mate Jacques Kallis retired from test cricket in December though he wants to remain part of the one day side -- had said only on Friday that he still had things to achieve in international cricket.
However, after another batting failure in the present series, he made just five in the first innings on Monday he decided it was time to call it a day and told his team-mates of his decision.
"I have a young family to consider, and I felt that retiring at Newlands would be the best way to end it because I have called this place home since I was 18 years old."
Smith captained South Africa in 108 Test matches, including the present match, over 11 years.
He also captained a World XI against Australia in Sydney in 2005. His total of 109 Test captaincies is 16 more than the previous record held by Allan Border of Australia.
His shock announcement came after he told journalists at his pre-Test press conference on Friday he had no plans to retire.
"There are still things I want to achieve in the game," said Smith, who when he first led the side, against Bangladesh in 2003, was the third youngest captain in Test history.
Under his leadership South Africa rose to become the number one team in Test cricket.
South Africa have not been beaten in a series since Australia beat them in 2008/09 - although they are in danger of defeat in the current third Test in a series which is tied at one-all.
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