Vertebrate forelimbs arise as bilateral appendages from the lateral plate mesoderm (LPM). Mutants in aldh1a2 (raldh2), an embryonically expressed gene encoding a retinoic acid (RA)-synthesizing enzyme, have been used to show that limb development and patterning of the limb bud are crucially dependent on RA signaling. However, the timing and cellular origin of RA signaling in these processes have remained poorly resolved. We have used genetics and chemical modulators of RA signaling to resolve these issues in the zebrafish. By rescuing pectoral fin induction in the aldh1a2/neckless mutant with exogenous RA and by blocking RA signaling in wild-type embryos, we find that RA acts as a permissive signal that is required during the six- to eight-somite stages for pectoral fin induction. Cell-transplantation experiments show that RA production is not only crucially required from flanking somites, but is sufficient to permit fin bud initiation when the trunk mesoderm is genetically ablated. Under the latter condition, intermediate mesoderm alone cannot induce the pectoral fin field in the LPM. We further show that induction of the fin field is directly followed by a continued requirement for somite-derived RA signaling to establish a prepattern of anteroposterior fates in the condensing fin mesenchyme. This process is mediated by the maintained expression of the transcription factor hand2, through which the fin field is continuously posteriorized, and lasts up to several hours prior to limb-budding. Thus, RA signaling from flanking somites plays a dual early role in the condensing limb bud mesenchyme.