Abstract-Impedance matching balance transformer is often used as the main electrified railway traction substation transformer. In order to solve the problem that traditional fault diagnosis method could not accurately identify the internal or external failure, it is proposed an identification algorithm of recursive least square parameter estimation online to distinguish the internal fault from external fault, which is based on that the winding resistance and short circuit reactance values have not been changed in normal operation for impedance matching balance transformer or external fault, but they have been changed for internal fault. The curves of simulation proved that the proposed algorithm could effectively distinguish internal fault from external fault. The research results show the feasibility to identify two sorts of different faults.