Although I don't use the 4cm my experience tells me you should be using the "Line Level" setting. 

The methodology explained the best way I can is this - turn the volume on your cleanest things up loud and keep anything that adds hiss or hum at minimal volumes.  The thinking is that you do not want to amplify that hiss in any way.  I suggest doing some research on what's called "unity" volume levels.  What's hard to determine is how your amplifier will react to the POD HD because they can all be very different.

First, you want to match the signal going into the amp (gtr input) so that the level coming out of the PODs FX send is just as loud as your guitar would be (that's reaching unity)  Then, going into the FX loop (from the PODs output) you usually want to have a very loud signal.  If the master volume on your amp is located after the fx loop return you will want to turn that down and try to reach a unity volume level with the HD for what it would sound like if the HD was not in the loop at all.  Hopefully that makes sense.

Go here for some more info on the 4cm:

http://line6.com/support/thread/74159

there is also a video tutorial somewhere.  This seems like a good one:

http://www.youtube.com/watch?v=SIBrtSTemUk