TNG tried its hand at horror a few times during the run of the series, and this is probably the best attempt. It's an excellent psychological thriller, and even when we find out that there's a "perfectly reasonable scientific explanation (TM)" the tension continues to climb. The crew - particularly Patrick Stewart and Gates McFadden - do a great job of portraying the crew's gradual descent into madness.
There are two particularly powerful, intense sequences - Worf's attempted suicide and Beverly's hallucination in the morgue. Guinan's sheriff scene in Ten Forward injects some levity.
TNG often struggled to find satisfying conclusions to its best episodes - given a seemingly insurmountable challenge, the writers often used "outs" that seemed like cop-outs. I would put this episode's conclusion into that category. Not bad, but I would have liked something better.