Digital-analog hybrid simulation method combines the advantages of both real-time digital simulation and physical simulation, and will be an effective means for the simulation and analysis of future power system. However, the ideal transformer model (ITM), as the most widely used interface algorithm, is easy to encounter instability issues. A novel impedance compensation algorithm based on ITM is proposed to improve the stability. By adding same-amplitude negative impedance to the digital subsystem and positive impedance to the physical subsystem, respectively, the hybrid simulation can be ensured to meet the stability condition. Parameter identification method is applied to identify the equivalent impedance before compensation, and is helpful to determine the appropriate compensating impedance. The simulation and analysis with pure resistance network and impedance network, respectively, have validated the effectiveness of the proposed algorithm, and this method can be implemented easily and conveniently.