Abdul Razzaq, 43, confronted the woman after she produced a huge kitchen knife in Barnsley town centre and shouted “kill, kill, kill, kill” as she stabbed one man in the shoulder and then walked around the busy streets.
Mr Razzaq followed the 6ft-tall woman, who was dressed in Muslim clothes but did not have her face covered, and alerted police to where she was in the town’s railway station.
He said he then convinced her to put down the knife before police officers grabbed her and made the arrest.
Mr Razzaq said the woman told him: “I’m no terrorist.”
Another witness said the woman shouted: “In the name of Jesus.”
The trader, who has run his clothes stall on Peel Square for more than 15 years, was speaking as shoppers came to shake his hand and congratulate him on his bravery.
Mr Razzaq described how the woman got a knife as long as his forearm out of its wrapping and discarded the packaging in a bin right in front of his stall.
He said she was just shouting “kill” over and over as she went to stab one man.
He added: “I ran for this lady and she was saying ‘kill, kill, kill, kill’. Everybody was scared. Everybody ran.
“I followed this lady. I said ‘don’t touch anybody’. I said ‘kill me but don’t touch my people. Keep that attack for me’.”
Mr Razzaq said: “I said ‘you’re a terrorist’. And she said ‘I’m no terrorist’. I said ‘you’re a terrorist because you do this’.
“I said ‘why do you attack the people?’. And she just said “kill people, kill people’.”
Mr Razzaq described how he followed the woman around the town centre as dozens of shoppers moved out of her way.
He said she was walking and kept shouting “kill, kill, kill, kill”.
After he returned to his stall, he told police she had gone to the bus station and he went with them to where they cornered her at the nearby railway station.
He said: “I said ‘that’s the lady’. She still had the knife and said ‘kill, kill, kill’.
“The police said ‘leave this knife’. Police were a little bit scared. I’m not scared. I’ll go near to this lady. I said ‘nobody’s going to touch you, leave this knife’.”
He said she said “kill, kill, kill” again but she threw the knife on the floor and police jumped on her.
Mr Razzaq said: “People were scared. They were really scared.”
South Yorkshire Police confirmed one person had been arrested following the incident at about 8.20am on Saturday.
The force said: “An investigation is now under way and in its early stages to establish whether this is an isolated incident and whether the individual acted alone.”
It is believed only one person was hurt in the incident and his injuries are not serious.
A number of bins and others areas in Peel Square were cordoned off and white-suited forensics officers were examining the scenes.
People working in shops in Barnsley Interchange station said they saw officers rushing around the area at around 8am.
Hannah Fuller, 24, a member of staff at the Subway sandwich shop, said officers rushed towards the railway platform and businesses had been forced to close for an hour.
She told the Press Association: “We had to close for an hour - Peel Street was closed. The police haven’t told us anything.”