I will explain you step by step to reset your Ipod touch to factory setting if you forgot your Ipod Password, 

First Step

Plug your iPod Touch into your computer using your USB cord. Start the iTunes software. Your iPod should begin to sync automatically. If it doesn't, click the iPod under "Devices" on the left side. On the "Summary" page, click "Sync" in the bottom right corner.

Second step

Click the "Restore" button. You will receive a prompt to back up your device. Select "Yes." If you choose "No," you will lose all of your iPod data. Click "OK." Your device is restored to its factory settings. This removes your password and all of your information.

Third step

Click the device on the left navigation pane. On the "Summary" page, click "Sync" in the bottom right corner. You receive a message that this device was previously synced with this computer. Select the radio button next to "Restore from the backup of," and click the drop-down arrow. Choose the most recent backup. Click "Continue." The information is synced back onto your device.