In Drosophila embryos the protein Naked cuticle (Nkd) limits the effects of the Wnt signal Wingless (Wg) during early segmentation. nkd loss of function results in segment polarity defects and embryonic death, but how nkd affects Wnt signaling is unknown. Using ectopic expression, we find that Nkd affects, in a cell-autonomous manner, a transduction step between the Wnt signaling components Dishevelled (Dsh) and Zeste-white 3 kinase (Zw3). Zw3 is essential for repressing Wg target-gene transcription in the absence of a Wg signal, and the role of Wg is to relieve this inhibition. Our double-mutant analysis shows that, in contrast to Zw3, Nkd acts when the Wg pathway is active to restrain signal transduction. Yeast two hybrid and in vitro experiments indicate that Nkd directly binds to the basic-PDZ region of Dsh. Specially timed Nkd overexpression is capable of abolishing Dsh function in a distinct signaling pathway that controls planar-cell polarity. Our results suggest that Nkd acts directly through Dsh to limit Wg activity and thus determines how efficiently Wnt signals stabilize Armadillo (Arm)/beta-catenin and activate downstream genes.