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The eight-time major champion, playing in his 43rd Masters, had hoped to make the cut but seven bogeys prevented a dream weekend goodbye.
The American, 66, received a standing ovation as he finished his second round with a par at a packed 18th green.
"To finish playing at Augusta with my friends and family watching - that's the way to go out," he said.
"The fans were really very generous with their applause, it was a pleasure."
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He completed his 134th and last round in the Masters with a long snaking putt at the 18th that stopped just inches away from what would have been a fitting final birdie.
He was then embraced by a waiting gallery of family, Augusta Green-Jacketed officials and former golf rivals with hundreds of fans surrounding the green.
"I hope that over the period of my career, I've been able to show the crowd some great golf," he added.
Watson, whose two Masters wins came in 1977 and 1981, said that the only regrets he had over his long career was not winning a few more majors.
"I know I won probably more than my share, but on the other hand, there are a few that got away. I guess it all balances out in the end, just like they say," he said.
Last July, he marked his final appearance at the Open with an emotional walk up the 18th fairway at St Andrews at the end of his second round.
But he said Friday's walk up the 18th at Augusta National was even more special.
"There's more finality in this walk here, because I really have made the decision that the kids hit the ball too far. I can't compete against the kids," he said.
"This course really shows the difference. You've got to hit the ball a long way to play this golf course."
Two-time Masters winner Tom Watson waved an emotional farewell to Augusta after carding 78 to finish eight over.