Simon Cox, Darius Henderson and Jamie Mackie all scored after coming off the bench for the hosts, with Cox's second of the game sealing Forest's fourth consecutive home win in the Championship in the last minute.
Billy Davies' side looked dead and buried after 47 minutes when Watford defender Gabriele Angella capitalised on some slack marking to put the visitors 2-0 up with his second of the match.
However, half-time substitute Cox got Forest back into the game 11 minutes later, before ex-Watford striker Henderson equalised with 17 minutes remaining.
Mackie then got in on the act just 90 seconds after coming on to put Forest ahead in the 82nd minute, with Cox rounding the scoring off in style.
Watford went in front courtesy of an outrageous backheeled volley from Angella on 33 minutes.
The 24-year-old Italian met a corner at the front post and acrobatically diverted the ball beyond Forest keeper Karl Darlow, despite the best efforts of Gonzalo Jara on the line.
Davies' men responded well to this setback, but were made to pay for some poor defending early in the second half as a completely unmarked Angella headed home Sean Murray's free-kick.
Cox pulled a goal back just before the hour mark as he converted Guy Moussi's fine header back across goal from close range, and Henderson wiped out his old club's lead just four minutes after being brought on with a stooping header from Andy Reid's sublime cross.
Reid was again the architect for Mackie's goal, as the Irish playmaker stood a perfect ball up to the back post for Mackie to nod home.
And Cox then put the gloss on a remarkable comeback with another fine finish in the 90th minute.
The result moves Forest to within four points of fourth-placed Derby, while Watford - who are now winless in four league matches - remain 16th.
