Neuronal Wiskott-Aldrich Syndrome protein (N-WASP) transmits signals from Cdc42 to the nucleation of actin filaments by Arp2/3 complex. Although full-length N-WASP is a weak activator of Arp2/3 complex, its activity can be enhanced by upstream regulators such as Cdc42 and PI(4,5)P₂. We dissected this activation reaction and found that the previously described physical interaction between the NH₂-terminal domain and the COOH-terminal effector domain of N-WASP is a regulatory interaction because it can inhibit the actin nucleation activity of the effector domain by occluding the Arp2/3 binding site. This interaction between the NH₂- and COOH termini must be intramolecular because in solution N-WASP is a monomer. Phosphatidylinositol 4,5-bisphosphate (PI(4,5)P₂) influences the activity of N-WASP through a conserved basic sequence element located near the Cdc42 binding site rather than through the WASp homology domain 1. Like Cdc42, PI(4,5)P₂ reduces the affinity between the NH₂- and COOH termini of the molecule. The use of a mutant N-WASP molecule lacking this basic stretch allowed us to delineate a signaling pathway in Xenopus extracts leading from PI(4,5)P₂ to actin nucleation through Cdc42, N-WASP, and Arp2/3 complex. In this pathway, PI(4,5)P₂ serves two functions: first, as an activator of N-WASP; and second, as an indirect activator of Cdc42.