The Night Hag must be within touching distance.
Touch means touch
The 'magically' in 'magically touch' describes the nature of the touching; it does not modify the basic meaning of the word touch. If that were the case, it would be specified in the description. 'Magically' here serves two purposes:
- To explain that the Night Hag can touch a creature on the Material plane from the Border Ethereal. This would usually be impossible.
- To class the action as a magical effect, which can be countered magically. Specific magical safeguards are listed in the action's description, and the magical effect would be nullified by an Anti-magic field
Note also the specific limitation that:
As long as the contact persists, the target has dreadful visions.
'Contact' here means 'contact'. The effect depends upon the Night Hag's contact with the target.
A magical effect with no limitations on who it can target is unbalanced and unprecedented
Imagine for a moment that the Night Hag does not need to be in physical proximity to the target. In this reading, there are zero limitations on who the target can be (save that they're not under the effect of one of the listed safeguards). It's totally consistent with this reading that the Hag could hear about a player character second-hand, or just have a passing knowledge of the ruler of the domain, and then make them the target of 'Nightmare Haunting', even from an infinite distance away or on the border ethereal of a different plane.
It's obvious that this is unbalanced, and it's inconsistent with the precedent set for similar magical effects. Compare this boundless targeting with the descriptions of spells like Scrying or Teleport, whose magical effects have an unrestricted range but are bound by common constraints:
- The target must be on the same plane of existence as you
- The chance of success depends upon your familiarity with the target
Nightmare Touch does not have a save: to suggest that it can always succeed, regardless of distance, is to suggest that a CR 5 monster has a kind of magical power unavailable to a 13th level Wizard.
Under the alternative reading, there's no need for etherealness
The border ethereal, as you have explained in your question, is the 'shore' where the ethereal plane overlaps with the other planes. Let's think for a moment about the two readings of Nightmare Haunting we're comparing, and how each of them interacts with the Hag's presence on the Ethereal Plane:
- If Nightmare Haunting requires touch in the physical, intuitive sense: The hag shifts into the border ethereal. From here, she move freely through obstacles and remain unseen. She can slip through the walls of your encampment, totally invisible, and magically touch you to make you the target of Nightmare Haunting. Pretty flavourful, pretty scary, and reasonably constrained: you could see her with truesight or Etherealness
- If Nightmare Haunting only requires a conceptual, abstract touch: The hag shifts into the ethereal plane (presumably the border ethereal). From here, she can use Nightmare Haunting to target you, even from the other side of the world. Why is she in the ethereal plane? What difference does it make to her or to you? Nobody knows. It is a strangely arbitrary constraint on an otherwise insanely powerful magical effect.
Note that the assumption that the Hag's Etherealness ability sends her to the location that overlaps with hers on the ethereal plane is the only reasonable assumption. For one thing, that matches the effect of the 7th level spell of the same name. Apart from that, the alternatives are both ridiculous:
- The hag can move to any point on the ethereal plane, and control this movement: The hag has unlimited teleportation within the Ethereal and Material planes.
- The hag can move to any point on the ethereal plane, but cannot control this movement: Very silly, obviously not the case.
The Night Hag must be within touching distance on the Border Ethereal in order to use Nightmare Haunging.
- Touch means touch - no special definition of touch is specified
- The alternative is unprecedented and overpowered
- The alternative makes the involvement of the ethereal plane redundant