Usually this phrase - "out of touch with reality" - means that someone has a strong belief that is not based in fact and cannot be mathematically proved and cannot be experimentally proved.
In business, it is a blueprint for someone to go bankrupt. I once worked for a company where the VP of Marketing made predictions that were out of touch with reality. He said we would sell X units of our products, so we geared up to make that much, and the real answer was like, 1% of X or worse. The company was going to fold but we got bought out first.
In medical care, it is a blueprint for someone to get really sick. If someone doesn't watch what they eat and doesn't take care of their bodies, they are out of touch with reality. They get diabetes, liver disease, lung diseases, etc. and then live a miserable existence for the rest of their (now shortened) lives.
In everyday life, it is an accident waiting for the right moment to happen. If some driver thinks he can weave in and out of traffic like an Indy 500 driver, there will come a time when he has something that most Indy car drivers experience - a massive pile-up.
So "out of touch with reality" is when someone's behavior doesn't seem appropriate to their current situation.