Goals from Javier Hernandez and Marko Arnautovic meant the Hornets were unable to draw on the confidence gained from the 4-1 win over Chelsea on Monday and instead lost an important fixture.
Speaking to Sky Sports after the game, Gracia said: "We were very soft during all the match. The first half we didn't compete in the best way and they were more aggressive and dominated areas and we didn't create clear chances to score. We will try to do better next time.
"Arnautovic played very well, he's a very good player, but he's not the most important for us at this moment, our performance is the most important thing and we need to improve and I hope we will do better next time."
Watford are now level on points with West Ham in 11th place and are at risk of being dragged into the relegation scrap engrossing the whole bottom half of the table.
Gracia added: "We try to look for consistency and to be more compact. We were able to do it in our last match and we try to do in the next one.
"Every match is important, today it was very important and the next one too, now I only focus on the next match, that is the best way to improve our level. In the next couple of weeks we have the chance to recover players who are out injured and work and rest, because we need both work and rest."
Watford host Everton in a fortnight's time in the hope of regaining the form which saw the Hornets start the season so brightly.