Can somebody explain to me what exactly cross-linking is, why it should be avoided, and what the penalty is for doing that?

I could not catch ur Question.

Did u mean Exchanging Links/Reciprocal Links.

If this is What u asked then i dont think there is no problem in that,cos i have exchanged links with a Number of sites.

Cross Linking is when a group of domains that are most often owned by the same individual inner link to each other. This is often for the purpose of increasing its popularity with search engines. In other words cross linking is Interlinking among web pages within the same website.

Excessive cross linking may be penalized by the search engines in the form of site drop down in search results and your site may even disappear from search engine results.

So u mean Link of Site#1 should not be exchanged with Site #2 ?

Theres no problem with exchanging of link#1 with link#2 but excessive cross linking should be avoided as it is believed to be penalized by the search engines.

Like my Site # 1 has 50 pages all having link to Site #2
and site # 2 has 3000+ pages all haviung link of Site #1
hence this is excessive?

Yes it might be considered excessive.

OMG then whats better ?

To remove links from 3000+ page site or the smaller one?

My idea would be to keep outlink from high PR site to the lower one.

And if both re same then......

I don't know.

Both are same cos all my sites are New and all are PR0 :( now