Series 3 is my favourite by a mile so I feel obliged to add my tuppeny worth.
It was the first series as I saw as a child and I was entranced from the off so it holds a lot of sentimental value, however I can see this doesn't represent a coherent arguement so here are some more reasons:
It contains the original (and best) life force sequence.
That pointless eyeshield thingamyjig hasn't yet been introduced.
There are no wooden glades, market squares or dragon rides which start appearing after Series 3. Er, I'm sorry fans of later series but Knightmare is set in a dungeon. Dungeons tend to be very much an indoor affair.
Treguard doesn't have an irritating sidekick.
Goblins. And that terrifying horn. DER NEEEER, DER NEEEER.
I liked Motley.
The team of wallies he failed to tell Motley about the snake behind him and who had a very short quest.
The spindizzy at the start of level two, the three steps to Merlin and the minecart ride.
Scary floating swords and axes.
Morghanna. She makes Lord Fear look like a Butlins holiday rep.
And in particular I like it because it was so very difficult. I feel that Hobgoblin's post sums this up very well. After Series 3 teams never failed to get through level one. If everyone is going to get through level one then why not just have two levels instead of three?
My one sore point - the killing of Cliff. I've written a long and rambling post about this on the episode thread but basically I believe they were a very strong team who didn't actually do anything wrong, and were the team who should have gone down in the history books as the only Series 3 winners.