What is a Lookalike Audience
A lookalike audience is an advanced feature that automatically generates an audience based on an existing audience. The resulting audience will as the name suggests be similar to the given one. This is achieved using advanced machine learning technology. For example when you create a lookalike audience on facebook, they can find people similar to the given audience, based on all their available information, like behaviour, interests, demographics etc.
Lookalike vs Custom Audience
Both actually has their own purpose. Usually you would use them together. It is very common to make a lookalike audience based on a custom audience. For example if you have a list of email of buyers from your webshop, you could use that to make a custom audience, and then make a lookalike audience based on that audience. This will give you a very nice potentially high converting audience.
Lookalike Audience size
Keep an eye out for the size of your input audience, if you base the lookalike audience on a too small input audience, facebook cannot draw any significant conclusions on who to include in the lookalike audience. This can result in a poor audience, and therefore poor conversions. So, try not to get the lookalike audience too small. Facebook advice that the recommended minimum size is 1000 people in the input audience.
Facebook has many great tools for creating audiences. Lookalike is just one of the more advanced and in my opinion, very attractive solutions.
If you want to look into the possibilities of Facebook targeting, check out my complete facebook targeting reference.
I also wrote an article some quick hacks to get you started with both custom and lookalike audiences.