Folding is just what it sounds like. You heat the metal, then hammer it down to a thin plate, or long bar, and then bend it, folding it back on itself. You then hammer it back on itself, welding the two bent halves together. This has two effects. First, it mixes carbon from the forge in with the steel. A high carbon content allows the steel to become harder during heat treating. Second, it helps remove any air pockets or impurities from the metal, creating a stronger blade. Also, different types of steel can be folded in, to create damascene patterns and other neat stuff. Incidentally, one of the reasons japanese swords were folded so much is that large quantities of quality steel were hard to come by, so they had to forge swords out of smaller ingots.
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