Want to prevent your Xbox Live account from being hacked? This is the best way. Microsoft, this week, unveiled two-factor authentication. Major Nelson already has a guide for setting up two factor authentication on your Xbox 360. Two factor authentication requires another device, like a mobile phone, which will provide a password to you so that when your Xbox 360 prompts for this extra password, you check your device for the randomly generated password and enter it.
Microsoft TechNet has an article detailing how two-factor authentication works with your Microsoft account (formerly known as your LiveID).