To arrive at the set of keywords that:
Describe business correctly (are relevant)
Attract traffic (are popular & are searched for)
Have less competition (are relatively un-optimized for )
Steps
Step I:
Lets start by saying that the for the keyword finalization of a web site the first step is to device the theme of the web site. The keywords then should be generated which are in sync with the themeing structure of the site. The home pages & the other higher level pages should target more general(main theme)keywords. The deeper pages (embedded in subdirectories or sub domains) should target more specific & qualified keywords.
Once the sites themes & sub-themes are done, lets start by looking for the keywords

StepII:
The finalization of the keywords for any given site can be done in the following way:
Generation of the seed keywords for the site (theme keywords).
Expansion of the seed keywords into key-phrases by adding qualifiers (sub theme keywords)
Generating a larger set of keywords by word play on the key-phrases generated in step II.(sub theme targeting)

Lets take them one by one:

SEED Keywords/Primary keywords:
The seed keywords can be generated by either of the ways mentioned below:
The client provides the terms he feels are relevant to his business.
The SEO firm generates the seed words by understanding the business domain & the business model of the client.
Some outside domain consultant provides them.

Another way of generating seed keywords is to look for the meta tags of the competition web sites.
WARNING: do not place any unnecessary emphasis on these tags. Use them just to generate you seed keywords list.
If one has certain set of keywords then tools like WT & Overture can also be used to arrive at the other relevant seed keywords.
Typically seed keywords are single word.
A good number of seed Keywords is between 10-12.

SUB theme Keywords (add Qualifiers)
Now to these seed keywords add qualifiers.
These qualifiers can be anything location/sub-product/color/part no/activity/singular etc.
By utilizing these qualifiers one can expand the list of the seed keywords.
Say a good number would be anywhere between 20-30.
Typicaly a sub theme key phrase could be of 2-3 -4 word length.
One recent study suggests that
The typical searcher often uses longer queries. Many contain more than three words. Within three different search engines, keyword distribution data tells a compelling story:

Words in Query LookSmart (%) Ask.com (%) Teoma (%)
1 27.00 12.76 38.04
2 33.00 22.46 29.59
3 23.00 19.34 18.13
4 10.00 11.89 8.00
5 7.00* 7.86 3.51
6 - 6.19 1.39
7 - 5.47 0.63
LookSmart does not report beyond 5 search terms, instead grouping five or more terms into one category.
Approximately 40 percent of queries in LookSmart have three or more words. About 32 percent in Teoma have three or more. Ask Jeeves has an even higher skew, nearly 62 percent, because of its natural language focus. Within FAST, the database that powers Lycos and others, the average is 2.5 terms. That suggests a similar frequency distribution to LookSmart and Teoma.
Hence we can keep the average length of sub theme keywords at around 3.


Keywords usage in the Meta Tags
Once the sites keywords have been finalized it is now time to start using them to optimize the site.The first & most obvious place to start using them is the meta tags of the site.
There are three metatags that we can start to use them with.
Header
Description
Keywords
Lets look at them one by one:
KEYWORDS and KEYPHARASES uses in THE META DESCRIPTION TAG :
The Meta Description text is used to display a short description of the web page which is listed in the search result by search engines. The Meta Description text should be attractive and meaningful so that it could give exact information about site services. It is very important from keywords inclusion angle as well for the SE tend to index it first & perform a keyword matching with it. Also bear in mind that this text is displayed along with the site title in the SERPs. Hence it is the first introduction that visitors will read about you.
Example:

KEYWORDS and KEYPHARASES uses in THE META KEYWORDS TAG :
Without Meta Keywords tag we can get top ranking as Meta Keywords tag is less important, as far as search engine optimization is concerned. Still, it won't hurt to include it. Meta keyword tag is used to include all the keywords for which you would like search engines to rank your site. Meta keyword tag is not supported by all search engines now as it has been flagrantly spammed. Keyword meta tag contains keywords and key phrases separated by comma's that users may search. Keyword must not be repeated in the Meta Keywords tag more than three times(rule of thumb) and one must not repeat any keyword one after the other.
Example:

Keywords should be listed in order of importance. Size preferences for meta keyword tags are not same for all Search engines. For example, MSN, will accept a meta keyword tag up to 1024 characters long, while HotBot indicates 75 characters . However, some top-ranking pages of Hotbot's in various categories used meta keyword tags much larger than 75 characters. So, 1024 characters can be used as guideline.

KEYWORDS and KEYPHARASES usage in Header Tags
KEYWORDS and KEYPHARASES usage in header tags is very powerful in SEO(search engine optimization) . As headlines makes a page easier to read and helps in rapidly finding required information, it saves time. Headlines should be short and descriptive. Headline tag text should never have more than one full line of text. It is preferred to use header tags text H2 or H3 tags to gain additional points with search engines.
Header tags text (headline) provides the right kind of keyword and key phrase information to the search engines which helps in better indexing of the website in their database. Header tags text also helps to rapidly inform what the page is all about. So, we should integrate KEYWORDS and KEYPHARASES into header tags text (headlines). Heading should start with the keywords that are being targeted.. We should use the standard headline tags (, ,, ,, ).Also better control over the layout of web pages can be achieved by using cascading style sheets in combination with the headline tags.
For example :
"KEYWORDS and KEYPHARASES usage in Header Tags"
"KEYWORDS and KEYPHARASES useage in THE PAGE TITLE "
"KEYWORDS and KEYPHARASES useage in THE META TAGS ".


Keywords Importance and Uses
The first step in the area of search engine marketing (SEM) is to understand the relevance & importance of keywords. Keywords are the starting blocks of a successful SEM campaign.
So lets dig into this section of SEM (or specifically SEO, search engine optimization) by defining keywords & keyphrases.
KEYWORDS and KEYPHARASES Definition : site words or phrases which/that are matched with the search words or phrases of target audience using search engines are known as keywords and key phrases.
Importance of KEYWORDS and KEYPHARASES : Keywords and Keypharases are used to promote and market a website by improving search engine rankings.
Where to use KEYWORDS and KEYPHARASES for Offpage Optimization : The Keywords and keypharases are used as the anchor text to link to the site. Search engines specially google attach lot of importance to the anchor text hence if there is a keyword in it, the site gets promoted for that keyword.
The Keywords and keypharases are also used to advertise, promote and market site with PPC (pay per click) and PPI(pay per impression)
Where to use KEYWORDS and KEYPHARASES for Onpage Optimization : KEYWORDS and KEYPHARASES are generally used with HTML tags ( title tag, meta description tag, meta keywords tags, body tag , anchor tags, comment tags, heading tags, alt tags, table tags, form tags, list tags, formatting tags, frame tags, map tags, applet tags, etc.) and in url itself. Apart from this the keywords & key phrases are used in the text matter of the page.
These are also used to create KRPs (Keyword Rich Pages – where a specific KEYWORD and KEYPHARASE is repeated to get top ranking for that particular web page for a particular KEYWORD).
The strategy is to target one keyword or at maximum two, per page. Once these KRPs are produced it is easier to get these pages ranked with search engines. These pages then have links to other pages in the site & hence serve as the passage way for inviting in the surfer to investigate the site deeply. These Keyword rich optimized pages are also called 'Doorway Pages.'
So lets start to introduce the keywords where they belong:
KEYWORDS and KEYPHARASES uses in THE PAGE TITLE :
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Page title is the first element that search spiders' find on a web page and hence it stands to reason that the title of each page should be carefully crafted.
THE PAGE TITLE text is displayed by using ….. tags in the title bar of the web browser. As it is one of the most important element of the webpage therefore most important and essential KEYWORD AND KEYPHARASE (S) must be included in it. KEYWORDS and KEYPHARASES which are used in page title are used by search engines in their result listing and they are then used by the target audience as the hyperlink to access the website from the search engine results page(SERP).
Keywords in a title is generally upto 60 characters or less including spaces. Google cutsoff title text after 60 characters when it is displayed in the SERPs. To achieve high ranking on the search engines the main keyword or phrase for the web page should appear should appear in the beginning of the title on the page. The page title tag carries significant weight in most search engine algorithms.
Example:
The page title " keyword & kyphrases tutorial for search engine marketing " uses keywords ( keyword , keyphrases, tutorial, search engine marketing)
These keywords and keypharases are dependent upon the domain, nature and objective of the web site.
KEYWORDS and KEYPHARASES uses in THE META TAGS :
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Meta Tags : Meta Tags are html text which describe information about the web page. In other words they provide data about data(web page content). Meta tags are invisible on the web page. They do not appear in browser window. To access them one has to select View menu and then select sourcece option from menu bar of browser Each meta tag has both a 'name' and a 'content' attribute.
In fact Meta tags are one of the first elements I look at, while assessing a competitor web site.
Meta tags are placed after the tag (position of Meta Tags is not fixed. If you put Meta tags elsewhere the page will not suffer).
The purpose of using the meta tag is to add relevant keywords that could be used by search engines while indexing a page.
example


Keyword and description meta tags can hold up to 1000 characters . Keyword and description meta tags should not repeat same keyword more than seven times otherwise some search engines will regard this as spam. It is better to avoid those keywords and phrases that have nothing to do with the page although search engines do not punish pages that include keywords that cannot be found elsewhere on the page.
As you can see we have chosen not to include commas. The search engines don't mind and it opens up for new keyword combinations. "search engine optimization techniques" includes no less than eight keyword or keyword phrases, including "search engine" and "optimization techniques".