What is the "Unknown Sources" setting?
Its location in Settings→Security already makes clear it is a security related thing. If disabled (which is the default on most devices), the only source you can install apps from is the google-play-store. Only after enabling it, you permit apps from other sources to be installed -- a process known as side-loading.
What are the risks involved activating this setting?
Permitting apps from "other sources" to be installed on your device might introduce the risk of drive-by downloads -- at the most if you tend to simply click "OK" whenever a popup window asks you something (as you still must approve the side-loaded app's permissions). Actively installing apps from unknown sources might introduce the risk of malware as well, if those sources are "untrustable" or even just "unknown".
Why should I enable this setting then?
There are still good reasons to use this feature. After all, on each installation you have to acknowledge the permissions of the app-to-be-installed, even if those are trivial or non-existing. Good reasons are e.g. if you have trouble with some app, and the developer sends you a fixed version to test (at least, if you can trust him). It is also required to use 3rd party markets such as e.g. AndroidPIT or Amazon.