Three old ladies are sitting in a restaurant, chatting about various things.
One lady says, "You know, I'm getting really forgetful. This morning, I was standing at the top of the stairs, and I couldn't remember whether I had just come up or was about to go down."
The second lady says, "You think that's bad? The other day, I was sitting on the edge of my bed, and I couldn't remember whether I was going to bed or had just woken up!"
The third lady smiles smugly. "Well, my memory's just as good as it's always been, touch wood." She knocks on the table. With a startled look on her face, she asks, "Who's there?"
If you are smug, you know you are the best, or have the best of something, in this case, memory.
We say 'touch wood' when we have something good and we don't want to lose it. You may well have a similar expression in your own language.
To knock means to use your hands to hit something, as you do with a door.
Startled means very surprised.
The old woman obviously forgot she had knocked on the table and thought someone was knocking on the door.