McGugan was a free agent after his contract with the Reds expired on Monday and the Hornets have acted quickly to sign the midfielder on a three-year deal with the option of a further 12 months.
The 24-year-old will now join his new team-mates on a pre-season training camp in Italy.
Watford boss Gianfranco Zola told the club's official website: "Lewis is a very talented player and an excellent signing for this football club.
"He will give strength to our squad and I'm sure our supporters will be excited to see what he can do in a Watford shirt."
McGugan came through the Forest youth system and scored 44 goals in seven seasons as a first-team player at the City Ground.
- Sports & Recreation
- Gianfranco Zola