I've used two colors of rubbing compound. The red/orange color is more abrasive. Use a white color compound that has the car polish wax in it. Less abrasive, thinner and easier to apply.
Yes both can be thinned with a bit of water. Use a restaurant type plastic bottle (ketchup / mustard). Spray bottles won't work.
Think: the plastic honey bottle for the mixture and squirt in on and buff it out. Water will no cause any problems.