First of all, this paper analyzed the basic principle of the nearest neighbor algorithm. However, a large amount of unnecessary calculation occurred when regarding all the reference tags as the choice of the nearest neighbors. At the same time, the interference was bigger in the indoor environment, and then readers far from the tags read the inaccurate signal strength value. This paper proposed a new RFID indoor positioning algorithm, which used the space division of virtual grid and selected nearest neighbors dynamically to locate. The simulation results show that the position precision and the stability of the improved algorithm without the increase of reference tags are much better compared with the nearest neighbor algorithm.