Self-mixing interference in laser diodes occurs when light is reflected from an external surface back into the laser cavity. A displacement sensor based on this effect is attractive for its simplicity and low cost; the only necessary optical components are the laser diode, collimating optics, and the reflector. This paper examines the limitations placed on such a system by the effects of thermal and mechanical instabilities. The accuracy and dynamic range of any laser diode-based interferometric sensor is limited by the sensitivity of the operating wavelength to temperature fluctuation. It is shown here that optical feedback can be used to reduce the wavelength sensitivity, and hence increase the potential accuracy, by a factor of two. In the case of misalignment of the reflector, it is shown that, although the output of a laser diode with optical feedback is normally very sensitive to the alignment, if a small alignment is introduced deliberately, feedback can be obtained from light making a double-pass of the external cavity. This leads to a reduction of the sensitivity to alignment and, at the same time, doubles the potential resolution of a sensing system.