Don Quixote has read so many romance novels about knights riding around the countryside saving people from danger that it drives him to madness (insanity) and he decides to become a knight himself. In one of the most famous scenes, he mistakes windmills for giants and attacks them full tilt, of course only hurting and making a fool of himself.
Bluntschli describes Sergius as equally foolish for charging into battle with delusions of grandeur and, as result, putting his men into grave danger. As Bluntschli puts it to Raina, Serguis was
shouting a war-cry and charging like Don Quixote at the windmills. We nearly burst with laughter at him; but when the sergeant ran up as white as a sheet, and told us they'd sent us the wrong cartridges, and that we couldn't fire a shot for the next ten minutes, we laughed at the other side of our mouths.
Bluntschli calls Serguis as insane as Don Quixote:
Of all the fools ever let loose on a field of battle, that man must be the very maddest.
Cervantes's point, at least on one level, is that such deluded, romantic foolishness only creates trouble, and Bluntschli uses this to illustrate his point about Sergius, knowing that Don Quixote was a common reference point, a widely read story a woman like Raina would surely be familiar with.
In all of literary history, these two characters have the most Romantic view of war. Don Quixote, of course, in his deluded state, believes he is in the Golden Age of chivalry, where the warrior’s duty is to fight the Giants (actually windmills) of the earth. Sergius, young and naïve, accidentally leads a charge because his horse panics, and to the world (and consequently in his own mind) he appears brave, but does not realize the stupidly, the senselessness of war; he is praised by Catherine and Raina for his bravery, which, like Don Quixote’s, is really only delusion. Shaw’s real hero, the chocolate soldier, is, on the other hand, less than enamored by violence, and provides a contrast to Sergius’ deluded worldview. “We'd no bayonets--nothing. Of course, they just cut us to bits. And there was Don Quixote flourishing like a drum major, thinking he'd done the cleverest thing ever known, whereas he ought to be courtmartialled for it. Of all the fools ever let loose on a field of battle, that man must be the very maddest. He and his regiment simply committed suicide--only the pistol missed fire, that's all.” Shaw’s parallel between the two hero-solders is that both are deluded, not seeing the real world but living and acting in a make-believe world where bravery is rewarded simply because the universe is just.