Thermal compound is a chemical that is used between the Heatsink (heat distributor) and your Central Processing Unit. It is used to distribute the massive amount of heat generated by your Central Processing Unit to the Heatsink which then distributes the heat through the fins and/or by ways of a fan.
You generally only want to apply a pea sized drop onto the processor, and spread it around with a credit card, hard flat plastic etc... You don't want to use too little or too much; that can lead to over heating issues. As said before, a pea sized drop of Thermal Compound will suffice.
Here's a video on how to apply it, hope this answers your questions:
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