The displacement measurement system based on laser collimation technology has been used in many fields. The core device of measurement system is the position sensitive detector. Such as stray light, power fluctuation and noise of photoelectric signal processing circuit, these factors can affect the measurement accuracy. To solve these problems, a high-precision displacement measurement method based on laser modulation was presented. Laser was operated in a modulation mode, instead of continuous laser mode. A photoelectric signal processing circuit was designed and optimized, and a program based on Labview was designed to implement the functions such as spectrum analysis, bandpass filtering and mean processing. Through the experiments and analysis, the measurement stability of two methods was compared. The experimental results show that the fluctuation of measurement results decreases from 7 μm to 2.6 μm, The effectiveness of laser modulation was verified, which can reduce the noise effectively by filtering and improve the measurement accuracy within 3 μm.