I'm going to clear up a few things. All link exchanges are not dead. Link exchanges when implemented properly can still be very beneficial to your search engine rankings and can even drive traffic to your site.
Before I tell you how to do it right, let me tell you how to do it wrong. Any link exchanges promising hundreds or links immediately upon joining should be avoided unless the only search engine you care about is MSN (and even that may be ending soon). Exchanging links with every site under the sun is also bad. Using a link exchange as the only way you get links will also not be a path you want to wander down.
Okay, so now that I've taken all the fun out of it, let me tell you how to do it so that you avoid any search engine penalties and actually see your search engine rankings improve from link exchanges. First, find service or software that will allow you to manually seek and choose your partners. Second, once you're in, take your time. A few links here and a few there. Third, be consistent about it. Exchanging links should be done every week, or at the very least every month. You want the number of links to increase over time. Fourth, only trade links with sites that are related to yours. Also, make sure you visit the site you're linking to, you don't want to be linking to sites that are junk unless you want to be thought of as a junky site as well. Fifth, keep the number of links to under 10% of the total number of links pointing to your site. That means you're going to need other linking strategies, but that's okay, there are several available and you should be using them all.
So now you're armed with the knowledge of how to do link exchanges and stay in the good graces of the search engines. So the next time somebody starts proclaiming from their high horse about how link exchanges got them banned or hurt their rankings, just keep in mind that they were likely trying to use shortcuts to get artificially high search engines.
There are in fact a lot of good reasons for websites to be linked to one another, and the search engines know that. The thing the search engines don't want to see is a website that will only link to a site that will link to it. Make sure you have one way links pointing both into and out of your website in addition to your link exchanges and you'll be in good shape.
