Parties – who doesn’t like to be invited to the best party of the year? Some plan ahead every minute detail for this much-anticipated event while others prefer to be fashionably late to make a grand entrance. But who wants to arrive when the first guests are already leaving and the party is almost over?

Within the larger parties, there are VIP parties delivering extra heat, they are in gold (NYSEArca: GLD), S&P 500 (SNP: ^GSPC) and the Dow Jones (DJI: ^DJI).

Seeing how much fun everyone, especially the VIPs, is having, we simply have to ask: Is it too late to join the party?

Good news – bad news

Unlike many hot private parties, there are no bouncers trying to keep you out, there are no admission fees either. However, before you get all dressed and ready, you should know that joining the party may cost you dearly, even without front-loaded admission charges.

Fun has left the building

As it turns out, the party seems to be losing its pizzazz. Through the back doors, many – including VIPs – are leaving the party. Buying climaxes, as tracked by Investors Intelligence (II), have seen levels not seen in years.

Buying climaxes take place when a stock makes a 12-month high, but closes the week with a loss. They are a sign of distribution and indicate that stocks are moving from strong hands to weak ones. II’s research shows that sellers into buying climaxes are right about 80% of the time after four months.

II also reports that insiders selling activity outnumbers buying activity by a large margin, exactly the opposite of what a market ‘ready to party’ should do.

Get the best seats early

When it comes to profiting on Wall Street, arriving fashionably late can be quite costly. As the chart below shows, there are commonly three stages to a major rally. Latecomers miss the early stages of the rally while being confined to buying into higher prices.

Stage 1 starts with the bounce from the preceding bottom and tends to be quite powerful. Stage 1 gains usually coincide with the extreme pessimism found at the previous bottom and that’s why most investors, aside from buy-and hold, miss out on the initial stages of a rally.

If recognized in time, however, stage 1 represents the biggest profit opportunity and best risk/reward ratio. You could consider stage 1 the “low hanging” fruits of profits. On a risk-adjusted basis, stage 1 gains are the most desirable as downside risk is lower than in any other stage of the rally because stocks are closest to their lowest point.

Of course, those “low hanging profits” are only real profits if the prior decline didn’t slaughter you. In December 2008, the ETF Profit Strategy Newsletter warned subscribers of an impending downturn and recommended to use any reading above Dow 9,000 as a selling opportunity.

The profits in stage 2 are often more limited as the gains of stage 1 are being digested. Sometimes the fear that the market has gone too far to fast sets in. This brings uncertainty as to whether any declines will result in a retest of the prior lows. We saw such a “digestive period” from May to mid-July.

Too good to be true?

Even though stage 3 is accompanied by the sentiment that the worst is over and a new bull market is at hand, the profits presented by stage 3 are less desirable. Why?

Simply put, being invested throughout the tail end of any rally increases the odds for lower prices exponentially. On a risk adjusted basis, stage 1 and stage 2 profits are much more attractive than stage 3 profits.

A tough decision

Whether to buy at around Dow 10,000 or to sit in cash is a tough call. The ETF Profit Strategy Newsletter spared many investors from having to make this call.

After recommending to sell in early January when the Dow sat above 9,000, the ETF Profit Strategy Newsletter issued a strong buy alert via its March 2^nd Trend Change Alert. Investors who heeded that call got the VIP treatment for stages 1, 2 and portions of stage 3 of this massive rally.

Recommended ETFs such as the Financial Select Sector SPDR (NYSEArca: XLF) and Ultra Financials ProShares (NYSEArca: UYG) rallied 100% - 300% within a few months.

Is the party over?

There is no easy yes or no answer to this question, at least not yet. What we can see though is that many sectors and indexes have already checked out while the S&P 500 (NYSEArca: SPY) and Dow Jones (NYSEArca: DIA) continue to have a good time.

The SPDR KBW Bank ETF (NYSEArca: KBE) peaked on October 14^th. The SPDR KBW Regional Bank ETF (NYSEArca: KRE) reached its high even sooner, on September 16^th. Both banking indexes have been unable to reach new highs since. The same holds true for the financial sector and small cap stocks, such as represented by the iShares Russell 2000 Index (NYSEArca: IWM).

A sobering reminder

Last weeks announcement that Dubai World, a (partially) government-backed investment company, might be defaulting on $60billion worth of debt, served as a reminder of just how fragile the financial system remains a year after it nearly collapsed.

More importantly, the reaction to Dubai’s (the government’s) statement that it will not – once again, will not – back Dubai World’s debt shows the scope of disconnect between perception and reality. Stocks rose modestly even though the government of Dubai is leaving private lenders hanging. Under normal circumstances, this is simply a recipe for disaster as the implications are very far reaching.

When looking at the performance of real estate, banks and financial institutions – which have been lagging the broad market for the past 1 – 3 months – we have to wonder, what do banks know that we don’t? Odds are they see another wave of foreclosures and toxic assets hitting the fan before we do.

Fond memories or hangover?

Looking at the mood, it seems like this party has reached the morning hours and fatigue is starting to set in. The key question is whether participants will leave the gathering with fond memories or a major hangover.  In other words, should you buy the dips since higher highs are on the horizon, or sell the rally with a major correction looming?

If there is one thing investors can learn from history, it’s that when higher prices seem most assured is exactly the time when caution is warranted?

Back in 2000, the technology sector (NYSEArca: XLK) got investors excited about hot dot.com companies with no earnings, selling at $100 a share.

In the early 2000s, real estate was the wave of the future. Banks and financials, the companies that made the real estate bubble possible, led the next bubble leading to the 2007 market top. None of the 80% of economists that now believe that the recession is over saw the post 2007 recession coming.

And then, there was oil. About a year ago, it was commonly believed that the world was running out of oil and the only direction for crude oil price was up. After topping at $147/barrel in July 2008, crude tumbled to below $34 within less than eight months.

This doesn’t necessarily mean that the same outcome is in store for equities and commodities right now. But, it certainly shows that the time to be cautious is when most throw caution to the wind.

The ETF Profit Strategy Newsletter recommended exercising caution in September of 2008 and once again in January 2009. Both instances were followed by 30% declines. Each issue of the ETF Profit Strategy Newsletter includes a short, mid and long-term forecast for stocks and all other major asset classes. Some consider it their hangover protection.