Valencia slipped to 14th position on the La Liga table after suffering a 3-2 home defeat to Barcelona on Sunday, leaving them just six points above the relegation places.
Los Che have won just eight times in 2020/2021, drawing 12 times and losing 14.
Gracia was appointed Valencia manager before the start of the campaign but his dismissal means he leaves after less than a season in charge at the Mestalla.
Salvador Gonzalez has been placed in interim charge until the end of the season.
“Valencia CF announced this Monday the dismissal of Javi Gracia as coach of the first team," a club statement read.
“The Club wants to publicly thank him for his work and dedication during these months leading the team and wishes him the best of success for the future.
“Salvador Gonzalez ‘Voro’ will lead the first team on a provisional basis."
Part of Valencia’s struggles this season have been as a result of the loss of key players including Dani Parejo, Geoffrey Kondogbia, Ferran Torres and Rodrigo Moreno.
Gracia has previously managed the likes of Watford, Osasuna, Malaga and Rubin Kazan.
