The Briton had won three matches at a tournament for the first time this year but could not make it four as she lost 6-4 2-6 6-2 to Swede Sofia Arvidsson.
Arvidsson is ranked 146 in the world, but has been a top-30 player and defeated Watson in their last meeting.
Watson, 21, has slipped to 133 in the world from a career-high 39 in February after a bout of glandular fever.
Her quarter-final victory over American Alison Riske was her second against a top-100 ranked player during the week.
Guernsey-born Watson has dropped down from the WTA Tour to the second-tier ITF circuit as she aims to end a difficult year on a high.
She is outside the cut-off for automatic entry into January's Australian Open - the first Grand Slam tournament of the season - but can pick up valuable ranking points next week in Barnstaple.