A new encoding method for absolute angular encoder based on optical diffraction was proposed in the present study. In this method, an encoder disc is specially designed that a series of elements are uniformly spaced in one circle and each element is consisted of four diffraction gratings, which are tilted in the directions of 30°, 60°, -60° and -30°, respectively. The disc is illuminated by a coherent light and the diffractive signals are received. The positions of diffractive spots are used for absolute encoding and their intensities are for subdivision, which is different from the traditional optical encoder based on transparent/opaque binary principle. Since the track's width in the disc is not limited in the diffraction pattern, it provides a new way to solve the contradiction between the size and resolution, which is good for minimization of encoder. According to the proposed principle, the diffraction pattern disc with a diameter of 40 mm was made by lithography in the glass substrate. A prototype of absolute angular encoder with a resolution of 20" was built up. Its maximum error was tested as 78" by comparing with a small angle measuring system based on laser beam deflection.