Nightblood himself, unfortunately, doesn’t quite understand what good and evil are. (This is mentioned later in the text.) However, he knows that his master can determine who is good and who is evil—using the sword’s power to make people sick, or through other means. So, he pretty much just lets whoever is holding him decide what is evil. And if the one holding the sword determines—deep within their heart—that they are evil themselves, then they will end up killing themselves with the sword.