The Nightmare Entity is an enemy who makes its victims hallucinate about their biggest fear, clowns. After the hallucinations are over, he sends them to a nightmare-ish world, and after 4 minutes the entity will get you and steal your soul and sanity. Not much is known about this particular entity except for this. Never think of either him or clowns.
His only appearance was in the second episode of second part of season four, "The Real Nightmare"