Zola led the club to last season's Championship play-off final, but Saturday's defeat to Sheffield Wednesday left them in mid-table - as close to the bottom three as to the top six.
And a statement on the Watford website confirmed the Italian's resignation, after 18 months in the job, had been accepted "with great sadness".
In an open letter to supporters, Zola wrote: "I am writing this with a very heavy heart and after a lot of consideration, to tell you that I have resigned.
"First of all, this decision has not been made quickly. I mentioned after the game on Saturday that I wanted to think about things overnight and that is exactly what I have done.
"I must place Watford Football Club first in my thoughts and it is for this reason that I have taken my action.
"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."
Ian Holloway and Steve Clarke were installed as the early favourites to replace Zola by Sky Bet, while Torino boss Rolando Maran and Udinese head coach Francesco Guidolin were also prominent in the early betting.
Former Italy international Zola, following a glittering playing career with the likes of Napoli, Parma and Chelsea, enjoyed a two-year spell in charge of West Ham between 2008 and 2010 before being sacked and replaced by Avram Grant.
He was brought to Watford by the club's new Italian owners, the Pozzo family, in July 2012.
Zola added: "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.
"I have had supporters tell me that the Leicester game in May was the most amazing moment in their time supporting their club.
"I will always remember having been welcomed so warmly to this wonderful football club, to have been supported so fully and to have been able to share moments of excitement and joy that will always live with me.
"But this game does not wait and does not stop. There is always the next challenge and a new environment ahead which means nothing is ever the same.
"For now, I want to wish the players, the staff, the fans and everyone else who has Watford Football Club at heart my best wishes for the future.
"It has been a privilege and a pleasure to serve this club and I am sure we will see each other again one day."