It doesn't work with anything. Whenever I have full inventory, and I want to drag something that pops up in my vicinity window, I simply cannot. The item turns red.
It only works that I look at that item with my crosshair and the context sensitive action pops up, such as: put pipsi in hands etc...
Find an item that can be held in hands.
Stand near that item so it shows in your vicinity window on the left.
Try to drag that item straight to your IN HANDS window, it will turn red.
(Can be done only by looking at that item straight away.)
This is something that is just really annoying when you want to deal with items in your inventory and you just have to close it from time to time just to grab something.
Very true, upvoted for visibility.
Vice versa, you cannot drag items from the character's hands into the vicinity.