Saunders left Doncaster Rovers and took over at Molineux in January, but the West Midlands club have suffered consecutive relegations after losing their Premier League status in 2012.
The Welshman, 48, was in charge for 20 games, having taken over when they were 18th in the Championship.
Doncaster, meanwhile, were promoted to the Championship under Brian Flynn.
Wolves are now looking for their fourth manager since sacking Mick McCarthy in February 2012.
Immediately after his dismissal the club came close to appointing Steve Bruce, who has just led Hull to the Premier League . He had a second interview in March 2012 and thought he had got the job before the club had a late change of mind.
McCarthy’s assistant Terry Connor ended up being in charge for a four-month spell as Wolves slipped out of the top flight. Norwegian Stale Solbakken was appointed in the summer, before being sacked in January.
Saunders, who was also relegated from the Championship in the previous season with Doncaster, was then given the job on a rolling one-year contract. He won five, drew five and lost 10 of his 20 matches in charge at Wolves. It took 10 matches to earn his first win as boss.
The club lost their Championship status on a dramatic final day last Saturday after being beaten 2-0 by Brighton.
A club statement said: “Manager Dean Saunders has been informed by Wolves that his contract is to be terminated. Assistant manager Brian Carey will also be leaving the club.
“Wolves have now begun a recruitment process, which in conjunction with the board will be managed by head of football development and recruitment Kevin Thelwell.
“The club will now take as long as is necessary to make this crucial appointment and there will be no publicly communicated timescales.”
Wolves have become the first team since Swindon in 1995 to suffer back-to-back relegations from the top flight.
Only 12 teams have ever been relegated to the third tier in successive seasons in the 125-year history of the Football League, but Wolves are the first team to manage the feat twice.
The statement continued: “Wolves would like to thank Dean and Brian for their efforts in what has been a very difficult period for everyone, and wish them both the very best for the future.
