The 59-year-old departs with the Bairns second bottom of the table and without a win this season, having lost 2-0 at home to promoted Livingston on Saturday.
Houston had led his side to the promotion playoffs in the last two seasons and were expected to challenge again, but on Sunday, it was confirmed that the two parties had parted ways.
The coach said in a statement on the club website: "We are disappointed with the start to the season and the board and I have come to a mutual agreement that, to get the club moving again, it is best that someone fresh is brought in.
"It has been a decent three or so years; there have been some real highlights, including reaching the Scottish Cup final and finishing second, but we just fell short of the goals that we all hoped we could achieve.
"It wasn't down to lack of effort and I've got to thank the players again for all they have put in."
Falkirk technical director Alex Smith, the former Ross County and Dundee United manager, becomes interim manager of the first team for a second time following Houston's departure.