Abstract: Phase generated carrier (PGC) technology is the core technology of multi-wavelength fiber displacement sensor (MWFDS). In this paper, a square-wave phase modulation and demodulation (SWPMD) method is proposed. A corresponding optical system has been established for research purposes, which precisely controls the phase modulation of multi-wavelength beams using square-wave signals. Digital processing is applied to the collected interference signals to achieve phase demodulation, thereby reconstructing displacement information. The simulation experiment systematically analyzes the impact of modulation signals with different frequencies and changes in the initial phase of square-wave modulation signals on the accuracy of displacement reconstruction. The root mean square (RMS) error of displacement reconstruction remains stable within the range of 0.15 to 0.3 μm regardless of the modulation parameters. By applying the SWPMD method to reproduce complex displacement trajectories, the universality and effectiveness of the SWPMD method in improving the performance of MWFDS have been demonstrated. Finally, the reproduction of square wave displacement with different step sizes was calculated and analyzed, proving that the method proposed in this paper can theoretically achieve a resolution of 0.1nm displacement measurement.