Fault diagnosis is an important area in the nuclear industry for effective and continuous operation of power plants. All the approaches for fault diagnosis depend critically on the sensors that measure important process variables in the system. The locations of these sensors determine the effectiveness of the diagnostic methods. However, the emphasis of most fault diagnosis approaches is primarily on procedures to perform fault detection and isolation (FDI) given a set of sensors. Little attention has been given to the actual allocation of sensors for achieving efficient FDI performance. A graph-based approach, the directed graph (DG), is proposed in this paper as a solution for the optimization of sensor locations for efficient fault identification. The application of the DG modeling in deciding the locations of sensors based on the concepts of observability and fault resolution is introduced. A reliability maximization-based optimization framework for sensor placement from a fault diagnosis perspective is described. The helical coil steam generator unit of the International Reactor Innovative and Secure system is outlined to underscore the utility of the algorithms for large systems.