You certainly need both polishing cloths and polishing compount. I use cloths in a range from 2400 to 1200. Usually I follow the same process as described by ZoomZoom. In order to minimize burning through the paint, I like to stop sanding with cloths as early as possible. That depends on the smoothness of the paint, color, and the kind of paint used. If there is no significant orange peel and it's a lighter color, 4000 is usually my last grit; with black I go all the way to 12000.
I use two kinds of compound: the above mentioned ScratchX (it's excellent) and Meguiar's Mirror Glaze Show Car Glaze (#7) which I prefer because it gives an even better shine, does not leave white residue in the panel lines, and can be overpainted (if necessary
).
My prefererred wax is 3M Ultra High Gloss Paste Wax (which I happened to use for my real car). It beats everything else I tried (including modelling waxes) for shine. Use wax, once you are happy with the results from polishing.
A last hint on burning through the paint: I have done it a lot, and it still happens to me. ZoomZoom's tips are excellent. In addition, try using clear coat on all finishes. Besides its usual purpose it serves as an indicator while (wet-)sanding. If you find color on your cloth, your through the clear, time to stop. Also, some small blemishes caused by sanding can be carefully fixed with a brush. No need to repaint. Just give it another clearcoat and start sanding and polishing again. A great part of modelling is really fixing mistakes.