The State Emergency Service says people living in Echunga should be prepared for at least ankle-deep water through their properties if the 10 megalitre structure fails.
Concerns were first raised on Tuesday afternoon, with signs of "slippage" along the main wall.
Fears grew of a major collapse overnight, with an emergency warning put in place early on Wednesday and reaffirmed about noon.
The SES, SA police and SA Country Fire Service have been working overnight to notify households under threat.
Those most at risk have been advised to leave with some gathering at the local football oval, away from the immediate danger zone.
An SES spokesman said pumps were being used to take water from the dam and levels had been reduced by about half a metre so far.
He said the water level needed to be cut by a further metre to make the area safe, something that could take another 24 hours.
"Worst-case scenario is the main wall of the dam gives way allowing the water to come down into the town," the spokesman said.
"We're looking at about 30 to 40 properties that could be inundated with water.
"But at the moment it's still holding."
Roads have been closed to support community safety and officials are continuing to monitor the condition of the dam.
A sandbag collection point for local residents has been established at the Echunga CFS station.
Premier Peter Malinauskas said he was briefed on the situation earlier in the day but described it as a "moving feast".
The dam was last considered full in 2016 during heavy storms.
Recent heavy rains across the Adelaide Hills have caused major runoff, raising water levels.
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