It sounds like it's a memory issue. LM Studio has a built-in failsafe that triggers when the memory available to the language model becomes too small for the amount of data it wants to store. In this case, it trims out some of the data to make way for the new stuff. The default setting in LM Studio is that it will trim out the middle, leaving the start (typically the world rules and entities) and the end (at least the very last recorded chat) intact. The rest gets thrown out, which could explain why the AI thinks that you are at the start.
If it is that, you should try and see if you can't increase the allocated memory so that the model can remember more. Within LM Studio, when loading up the model, you should change the "Context Length" to a higher value. Maybe try doubling it for now.
You will have to apply the same number in-game under the "Max memory" setting so that Formamorph knows how much memory it has available.
I can say with 100% certainty that it is better to use free models via openrouter(there is guide on the main page) rather than running small models on your computer. To run smart and big models you need a high-end PC and small models, although they work, do not always do what you tell them and poorly follow the narrative