Defeat would have left the third-from-bottom Eagles seven points adrift off their opponents and five points behind Sheffield Wednesday, but instead they now only trail the Hornets by a single point, albeit having played one game more.
Luck was certainly on the visitors side during a first half in which their hosts were denied by the woodwork twice and had at least two other excellent chances, only to find themselves trailing to Stern John's 31st minute header.
But a second goal from Sean Scannell swung the tide firmly in Palace's favour and Neil Danns added the third, before Danny Graham scored a deserved consolation.
Eagles defender Lee Hills, who was sent off in the closing stages for a second yellow card, was fortunate not to see red in the 16th minute when he fouled Henri Lansbury and appeared to be the last man.
But that set the tone for what was to follow in the first half as a superb save from Julian Speroni kept out Martin Taylor's header before Tom Cleverley thundered a 25-yard shot against the Palace bar.
But Watford were stung in the 31st minute when Calvin Andrew wriggled away from Adrian Mariappa, his attempted pull back broke for Hills whose cross to the far post was headed in by the unmarked John.
More chances came and went for the home side before the interval, with Lansbury's header from a corner hitting the underside of the bar before Speroni thwarted Will Buckley from close range.
The Hornets were made to pay for not taking their chances six minutes after the restart when Scannell met a cross with a header that rebounded off the far post, but the rebound fell favourably and the Palace midfielder side-footed home.
And the home side's misery was completed in the 65th minute when keeper Scott Loach could only parry another Scannell effort and Danns tucked away the rebound.
After Cleverley hit the woodwork for a third time, the Hornets' efforts were finally rewarded in the 83rd minute when Buckley found substitute Graham on the rebound and he slammed a shot inside the near post.