Real-time and accurate monitoring of dynamic deflection is of great significance for health monitoring and condition assessment of bridge structures. This paper proposes an improved step-type liquid level sensing system (LLSS) for dynamic deflection monitoring. Layout of straight-line-type pipeline is replaced by step-type pipeline in this improved deflection monitoring system, which can remove the interference of the inclination angle on the measurement accuracy and is applicable for dynamic deflection monitoring. Fluid dynamics are first analyzed to demonstrate that measurement accuracy is interfered with by the fluid velocity induced by structural vibration, and ANSYS-FLOTRAN is applied for analyzing the influence range caused by the turbulent flow. Finally, a step-type LLSS model is designed and experimented with to verify the influence of the three key parameters (initial displacement excitation, step height, and distance from the measurement point to the elbow) on the measurement accuracy, and the reasonable placement scheme for the measurement point is determined. The results show that the measurement accuracy mainly depends on the turbulent flow caused by step height. The measurement error gets smaller after about 1.0 m distance from the elbow. To ensure that the measurement error is less than 6%, the distance between the measurement point and the elbow should be larger than 1.0 m.