The Reds would have been entitled to compensation - usually decided by a tribunal - as Sinclair is just 19 but the clubs have managed to come to an agreement which Press Association Sport understands will see the Merseysiders receive £4million.
In a statement Liverpool said: "His registration would have been subject to compensation in the form of a development fee.
"However, following amicable and professional discussions between Watford and Liverpool, the clubs have reached an agreement regarding a transfer."
Watford confirmed the signing of Liverpool's youngest player - who was aged just 16 years and six days when he made an appearance in a League Cup tie against West Brom in September 2012 - in a statement.
"Watford FC is pleased to confirm it has agreed terms with Liverpool over the transfer of striker Jerome Sinclair," it said.
"The highly-rated forward has penned a five-year deal at Vicarage Road and becomes the Hornets' first new signing ahead of the 2016/17 Premier League campaign."
Sinclair made five first-team appearances for Liverpool, scoring on his first start against Exeter in the FA Cup in January.
Source : PA
Source: PA