It technically says ambient temperature, and I would think they would take into account the watch being worn, but who knows... I've never had a temp issue with my watch in colder or hotter temps. My iPhone on the other hand...
Over the years of using iPhones, I have gotten the high temperature warning several times. What is especially irksome is that I can get it without the air temp being over 95 °F or the phone being in direct sunlight. Just the other day, I was taking some pics outside and had the little warning triangle, where the flash option is, saying the flash can't be used until the phone cools down. I think it was maybe 70° outside, and I hadn't been using the phone to cause it to get hot.