Certainly, the market currently feels like a risky place to do business. Indeed, 10-year highs in oil prices, an increasing number of corporations issuing earnings warnings, extreme volatility in the Nasdaq market, and uncertainties surrounding a change in the Oval Office are all weighing on the market at this time.

However, when discussing market risk, perception and reality may be two different things. Indeed, it is during such seemingly dangerous market periods that having a tool that puts market risk into perspective can prove invaluable. Fortunately, such a tool exists - the Intermediate Potential Risk indicator.

Before I discuss this indicator, I think it's important to make a few points. First, no single market tool is infallible, so investors should not base entire investment strategies on one indicator. Second, by discussing a tool that helps you gain an awareness of market risk, I'm not advocating you trade stocks aggressively based on perceptions of market risk. A buy-and-hold approach is still the best way to profit long term. Still, being able to assess market risk at any point in time may help you in a number of ways, not the least of which is to embolden you to continue to put money into the market during volatile market periods.

The Intermediate Potential Risk indicator takes the percentage of New York Stock Exchange (NYSE) stocks trading above their 200-day moving averages and quantifies this percentage in terms of market risk. A reading of 70% or more of the NYSE stocks trading above their 200-day moving averages constitutes "higher risk;" readings below 40% constitute "lower risk."

I like several things about this tool. It's easy to find the data. The percentage of NYSE stocks trading above their 200-day moving average is found in every issue of Investor's Business Daily newspaper. The information appears on what is called the "General Market" page, which is highlighted every day in the table of contents that appears on page one of the publication. Once you locate the "General Market" page, go to the chart of the Dow Jones Industrial Average on that page. On the Dow Industrials chart, you'll see a box showing price changes of the Dow 30 components for that particular day. Just under that box you'll find the piece of information showing the percentage of NYSE stocks trading above their 200-day moving average.

What I like about the indicator is that it provides a true picture of the popularity of stocks. The tool is useful for providing a snapshot of how stocks may have moved to extremes, relative to their average price level of the last 200 days. What underlies the indicator's effectiveness is the concept of "reversion to the mean." Basically, this concept means that, over time, stock prices tend to return to their long-term averages. A stock that is trading well above its 200-day moving average is likely trading at an unsustainable level and will eventually migrate back to its long-run average. Likewise, a stock trading well below its 200-day moving average should, over time, trend back toward its long-run average.

Keep in mind that the long-run average can change over time to reflect higher stock prices (which is why most 200-day moving averages trend upward), which is another reason I like to use this indicator. It is not a static indicator. In other words, it doesn't say that you should buy stocks when price/earnings ratios are under 15 and yields are over 3%. Such rules have not been very profitable in the last several years primarily because these rules don't adjust for changing market conditions, falling interest rates, low inflation, etc. The strength of the Intermediate Potential Risk indicator is that it provides a relative tool that can assess market risk at that particular market period.

Should investors trade aggressively based on this indicator? As I've already said, the answer is no. I think the indicator's greatest value is for determining how aggressively to put new money into the market. For example, if you make regular weekly investments to stocks, you might adjust the size of these investments depending on intermediate risk levels. Say the Intermediate Potential Risk is 75%. You might want to trim your regular investments by perhaps 10% to 20% until risk returns to at least neutral (below 70%). Notice I didn't say eliminate your investments. We're talking about fine-tuning a portfolio. Also, I don't think investors should alter investment programs based on minor moves in the risk level. Rather, the indicator is most useful when it runs to extremes, either on the upside (above 70% and especially above 75%) or the downside (below 40%). For example, I would not alter investment programs based on movements within neutral territory (40% to 70%).

What is the indicator saying about today's market? Currently, the percentage of stocks on the New York Stock Exchange trading above their 200-day moving average is 57%. This percentage puts the indicator in the middle of "neutral" territory. The indicator says that the market is neither cheap nor overvalued at current prices. How does that translate into what you should do as an investor? For starters, the market's risk level shouldn't panic you into selling stocks. Second, don't assume that, because the market has already pulled back rather sharply, the selling is complete. Third, if you have cash and find stocks to buy, go ahead and buy them.

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