The Hornets are bottom of the table having taken a single point but last term Gracia led them to the FA Cup final, where they were thrashed 6-0 by Manchester City.
Watford's poor form dates back to the end of the 2018-19 season, which they finished with three straight defeats.
"Javi has represented Watford with great dignity and will always be deserving of our fullest respect for his achievements," said chairman and chief executive Scott Duxbury.
Club Statement: Javi Gracia— Watford Football Club (@WatfordFC) September 7, 2019
Watford confirmed Gracia's staff will also be leaving the club, with the Hornets swiftly appointing Quique Sanchez Flores as his replacement.
Club captain Troy Deeney suggested in a recent interview that Gracia should be given time to turn the team's fortunes around.
"The manager is a big boy, he knows what he's doing – it's just part and parcel of the game," Deeney told Sky Sports. "People are always going to question the manager if we've lost a few games.
"It doesn't just happen at Watford, it happens everywhere, but the high turnover of managers at Watford was four or five years ago. Everyone thinks every year we change the manager and get a new one. We are trying to settle down."
Watford have had 10 bosses since Malky Mackay's departure in June 2011, with Walter Mazzarri and Marco Silva among their recent coaches.
Former boss Quique Sanchez Flores has returned to take charge at Vicarage Road.