What are the limitations is a great question!
You can definitely use it on any sized piece of knitting in the round. I use it a lot when I knit garments with hand-dyed yarn for blending each skein in.
The limitations of your yarn choice are really just dependent on what effect you're after. If you want the stripes then you need yarns with sufficient contrast - solid colours work just as well as the gradual stripes of a Zauberball. It gets less stripey if you have really short sections of colour in your skein. For yarns like this (lots of hand dyes only have short sections on each colour as it's easier to dye like that), then pair them with a solid. Sometimes you don't want the stripes (like the example of blending in skeins of hand dyed yarn).
If you want stripes of more than one round in each colour, then you need to use solid yarns and more than one ball. So to make a stripe pattern that's 3 rounds in blue and 2 rounds in pink you'd need 5 balls of yarn joined in - 3 of them blue and 2 of them pink.
You can absolutely join in a heap of colours, but the more colours you use, the more angled your rounds start to look. So they will look more like a helter skelter than the normal seemingly horizontal rounds you're used to seeing.
Phew! That was a long answer. I can't think of any other limitations for now, if anything else occurs to me I'll try to remember to come back.