Reciprocal linking is an agreed upon link between two web sites - I link to your website and in exchange you link to mine. This is most often done amongst website owners for the purpose of increasing the "incoming" links to their website - one of the ingredients to achieve a high search engine ranking.
Google and other search engines do look at how many links are going into any one web site and in general the more links to your web site the better. But there are many traps to look out for with reciprocal links.
As search engines have become smarter in their fight against "search engine spamming" there are many linking schemes to steer clear of or you will find your website being penalised for spamming and you may even disappear from Google. As a general rule you can abide by the old standard -
if it sounds too good to be true it probably is.
Positive (or "White Hat") Linking you Should Do
First we'll look at what you should do.
Do setup reciprocal linking with your suppliers, complimentary (non-competing) businesses, friends (where appropriate to your business) and sometimes clients (again where appropriate).
In these link agreements you will place a link on your site going to theirs and they will return the favour. Typically these sorts of links are set up on their own page called "Links" or "Affiliates" or "Our Partners".
Do accept offers of "one way" links from other web sites (providing they are legitimate websites - see below in the "Do Not" section). These links may come from another website wanting to link to information on your web site which they think will benefit their customers. Or a one way link may come from a web site where you post an article or other industry information.
Encourage and search out these one way links.
One way links may also be paid for from directory websites which will typically benefit your search engine ranking - but of course the cost needs to be accounted for.
How Search Engines View Links
Reciprocal linking as per above is
equally beneficial to each other's websites providing that both sites are relatively similar in popularity and reputation. If one site is highly popular and the other is not, the less popular site will benefit much more by having a link from a highly popular website. This is because search engines do not just look at how many links go to your web site - more importantly
they look at the quality of the web sites linking to your site. It is for this reason that we will look at some of the things not to do below.
Negative (or "Black Hat") Linking you Should Avoid
Do not
submit your website to any link farms or linking schemes or any other automated service which promises that your site will be listed on hundreds or thousands of websites. This will most likely result in your site quickly being blacklisted by search engines.
Look very closely at any unsolicited offers from people you do not know or people who are not referred to you by somebody you trust. Generally I would advise to not even look at these offers as they are often just spam emails which may contain viruses or other malicious intents - but occasionally there may be a legitimate offer from a business complimentary to yours.
So Should you Do It?
As usual the answer is to use common sense. It is beneficial to pursue reciprocal and one way links to your web site. But do not take short cuts or reply to random invitations which will bring you "one million hits overnight" (you just might get those 1,000,000 hits - but I can assure you none of them will be paying customers).
For more information on linking and reciprocal linking,
view the Wikipedia page here