This paper presents an observer based actuator fault detection algorithm for an electro hydraulic system. A nonlinear observer is first designed which is robust with respect to model uncertainties and external disturbances. Then, the developed observer is applied for fault detection in a hydraulic actuator with unknown friction forces. This paper focuses on the small internal leakage that defined as an actuator fault and the leakage is detected by an adaptive threshold. In addition to theoretical analysis and closed loop stability proofs, simulation results are also included to show the effectiveness of the method in the presence of system uncertainties and disturbances.