A systematic method is employed for the design and analysis of a small size eddy current (EC) displacement sensor. Simulations are first performed to determine the optimal winding structure and dimensions of the sensor. A linear-fitting approach is then developed for converting the AC displacement signal of the sensor to a DC signal. Finally, a compensation method is proposed for mitigating the temperature drift of the EC sensor under different working temperatures. The experimental results show that the proposed sensor has a sensitivity of approximately 3 μm, a working temperature range of 25–55 °C, and a linearity of ±1.025%.