The X3 system has three volume control settings that operate as follows:

TRANSMITTER INPUT LEVEL:
  This sets the maximum game signal level transmitted to the headphones and 
  should be set as loud as possible without causing distortion. In most games,
  you can leave this set to maximum. If you hear distortion on loud parts in 
  the game, turn this control down a bit to reduce the level.

HEADPHONE GAME CONTROL:
  The volume control on the headphones also controls the game signal level, 
  but should be turned down to a comfortable level. For best audio quality, 
  the transmitter volume should be as loud as possible and the headphone 
  volume should be as low as possible for optimum game sound.

TALKBACK VOLUME CONTROL:
  Chat volume from other players during an Xbox Live gaming session is set 
  by the volume control on the "puck" inserted into the Xbox controller. 
  The game volume control on the headphones has no effect on this chat volume
  level. In other words, even if you turn down the game volume control you
  will still hear the chat signal if the "puck" volume is turned up.

BASS BOOST SWITCH:
  You can enhance the game audio quality by turning on the Bass Boost switch 
  on the headphones. When turned on, this will increase the low frequency 
  response of both the game and talkback signals to enhance the sound of 
  explosions, gun shots and other deep-bass sounds.

  
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