Nadal battled hard against David Goffin but eventually lost his opening round-robin match 7-6 (7-5) 6-7 (4-7) 6-4 and decided afterwards to call it quits for the season.
Heading into the Finals, the world number one admitted his knee was 'not perfect' and the pain kicked in again during the defeat against the Belgian seventh seed.
"I am off and the season is finished. I am really not ready to play," he said. "I really fought a lot during the match knowing probably it was a big chance [that it would be] the last match of the season.
"It's about the pain and I cannot hold with enough power to keep playing."
Nadal is guaranteed to end the year as the world number one and says he will now concentrate on recuperation before preparing for the new season.
"The good thing is [the injury] is nothing new," he added. "We hope to have the right rest, the right work and try to be ready for the beginning of the next season."