Infrared diodes are important components of photoelectric encoder, the orthogonality and sine of Moire fringe directly affect the segmentation accuracy and resolution of photoelectric encoder, and they affect the light source parameters. According to the investigation, the divergence angle and the width of light source exert a tremendous influence in signal of encoder. Firstly, the effect of light source on the grating signal flux was analyzed. The application of the frequency domain method helped deduce the function of light transmission feature; Then the impact of the two different light source on the signal creation with a yard plate and the contrast ratio was computed; Finally, orthogonality and sinusoidal property of the Moiré stripe signal were simulated at MATLAB environment. The result shows that the encoder accuracy difference between them reached 30% by applying different source. Higher harmonic proportion of the improved decoder decreases significaitly and the signal stability is better. Studying the light source parameters has great significance in extracting the Moire fringe of high quality, and offers valuable reference for designing high-precision encoder.