The Vicarage Road outfit have failed to register a victory in their last nine league fixtures, including five straight home losses.
Watford have failed to score in their last four home encounters, and the Italian's last match in charged proved to be a 1-0 defeat to Sheffield Wednesday - a result that left the club 13th in the standings.
The Italian took the reins at the club in July 2012, and led the side to the Championship play-off final in his first season in charge, losing 1-0 to Crystal Palace in the final.
But the team have been unable to match that form this season, and Zola believes the time is right to call time on his tenure.
Speaking to the club's official website he said: "I feel that it is in the best interests of the team that somebody new is given the chance to bring the success which we have all hoped for and worked very hard for.
"It is for a variety of reasons, and not just over one matter or one moment, that I feel this is the right decision for me, in the best interests of the club - and I know I can trust you, the supporters, to respect my decision fully.
"Last season was such an amazing time, for the players, the staff and the supporters. And I loved that journey. Every minute of it brought a new challenge, different experiences and a lot of learning."
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