Dynamic diffraction gratings can be microfabricated with precision and offer extremely sensitive displacement measurements and light intensity modulation. The effect of pure translation of the moving part of the grating on diffracted order intensities is well known. This study focuses on the parameters that limit the intensity and the contrast of the interference. The effects of grating duty cycle, mirror reflectivities, sensor tilt and detector size are investigated using Fourier optics theory and Gaussian beam optics. Analytical findings reveal that fringe visibility becomes <0.3 when the optical path variation exceeds half the wavelength within the grating interferometer. The fringe visibility can be compensated by monitoring the interfering portion of the diffracted order light only through detector size reduction in the expense of optical power. Experiments were conducted with a grating interferometer that resulted in an eightfold increase in fringe visibility with reduced detector size, which is in agreement with theory. Findings show that diffraction grating readout principle is not limited to translating sensors but also can be used for sensors with tilt or other deflection modes.