A newly developed electro-optical shaft angle encoder is described and the theory developed for a technique using laser interferometry to eliminate error sources and improve the resolution and accuracy of an encoder. The technique described in this paper utilizes a cw laser to illuminate the outer-most high-density tracks on a code disk made up of alternately opaque lines and transparent spaces. By focusing the laser beam to a small spot incident on the center of the track, a diffraction pattern is formed as the light passes through the code disc. By properly combining a given pair of order contributions by means of small plane mirrors, an interference pattern is formed at the input of a detector. As the disc is rotated, the radially formed line pattern on a given track will result in a continuous phase shift between diffracted orders which gives rise to a sine-wave variation in intensity of the interference pattern at the detector input. Counting this signal cyclically at the detector output will result in a direct count of the number of lines on the track that corresponds to a given angle of rotation. With this tech-nique, a 20-bit encoder has been developed on an Air Force Contract AF33(615)-3092, using a 2.5-inch-diameter code disc. The simplicity and basic stability of this approach are described along with the resolving capability of the encoder in relation to the available energy in the diffraction orders.