In order to improve the reliability of a two-axis Fast Steering Mirror (FSM) system with minimum hardware consumption, a fault detection method based on observer was developed. The dynamics model of the two-axis FSM was established firstly, and then the state-space form of the FSM was adopted. An observer for fault detection was designed based on the state-space form. Then the residual vector could be generated by comparing the output of the system with its estimation provided by the observer. Finally, the residual evaluation function was adopted, and a fault can be detected by comparing the residual evaluation function with a threshold. Experimental studies on a prototype system show that the sensor fault signal can be detected by the residual vectors timely and accurately. Meanwhile, the consumption of the hardware and space is decreased.