I agree with Jorrell, and I've seen your exact situation too many times to count on various people's Red-Block Volvos. Here's a rough step-by-step walkthrough of what happened.

1. Engine overheats, typically due to a blown Wahler (cheap) thermostat, or coolant hose break, or radiator inlet fitting crack, etc.
2. As the engine temperature soars, the Aluminum engine head expands at 1.5 times faster than the Iron engine block.
3. At extreme overheat (the top of your temp gauge), the head has expanded as far as it's maximum allowable travel, and it begins to press laterly on the head bolts at either end.
4. With no room to streach lenghtwise, the head begins to bow up in the center, and the head gasket looses integrity and cylinders #2 and #3 loose compression. In extreme cases, cylinders #1 and #4 may be comprimised too.

If you'd like to confirm this for certain, pick up a cheap compression tester from your local autoparts store. You can get them for as cheap as $35 if you shop around (CarQuest, Napa, AutoValue, AutoZone, Advance, etc). Run your engine for 10 minutes, then remove all 4 spark plugs, unplug your fuel injectors, and unplug one of the harness wires at the ignition coil. Use the compression tester on one cylinder at a time, and have an assistant crank the starter while holding the throttle wide open for 10 revolutions. Read the gauge and compare your numbers against the book specs. Off the top of my head, I think 145 psi is the low/failure mark, 180 to 195 is a healthy engine, and you are permitted a maximum of 10% difference between cylinders.

In the coolant resivoir, I have dirty looking gassy/oily smelling film. The car idles rough.

This can only occur if one of two events occur: A failure in the radiator where the transmission cooler line passes through the cold-side coolant end tank. -or a blown head gasket. You probably won't notice excessive steam in the exhaust unless the head gasket failure gets really, really bad. (to the point where you risk hydro-locking the engine from the massive draw of coolant) Right now, the head gasket failure is small enough that you have cylinder pressure is escaping around the head gasket, but isn't sucking in a huge amount of coolant yet (but you are likely drawing in some).

If you must drive your car in this state, I would advise you to loosen your cooling system pressure cap a full turn. If pressure builds in your cooling system faster than the cap can release it, you may blow either your heater core, radiator, or another hose.

How to proceed from here:
If you're good with your tools, and have the timing belt counterhold tool (or know where you can borrow one), you can replace the head gasket yourself. The instructions are in the Haynes book and most DIY mechanics can do this in a weekend or less (be sure to change the T-belt at the same time). If you'd rather not, call around and find a shop that you trust to do the work for you. Ask if you can provide the parts as you can probably get them cheaper.

Either way, if you do the work or a mechanic does it for you, you will need to have the head checked for flattness. During the overheat, the head may have become permenantly warped and you can machine off up to 1/2 a millimeter to flatten it out (book spec). I know people that have taken off as much as a 1mm without serious consequences and the reason why you shouldn't remove more is that it creates stress on the camshaft bearings. A local machine shop can machine it flat for you, and they usually charge anywhere between $30 to $50 for this. If you want it pressure tested, many will do that for another $50, but the chances that you've cracked the head are so slim that I wouldn't bother. If the head is warped beyond 1mm, I'd advise grabbing a used one from a salvage car in your local scrap yard. Be advised, the distributor and camshaft tail ends are different between the 240 and the 740/760 cars, and unless you want to swap camshafts and play with shim pucks, I'd suggest getting one that matches your car directly (240 head from a 240, and 740 head from a 740).

With your good head back from the machine shop (or a used one that's confirmed flat and good), bolt it back on your engine with a new head gasket. Save yourself $30 and don't buy new head gasket bolts, as they're TAT (Torque Angle-Tighten rather than TTY, Torque to Yeild) and do not need to be replaced. Replace the seal at the top of the waterpump, and lightly coat it with RTV for best longevity. The exhaust manifold gaskets have a stamp on them that says "UT" and this stamp faces "outwards" away from the engine. Hook up the two temp sensors and the knock sensors and the heater coolant lines, and then bolt up the intake manifold with a fresh gasket. After your timing belt and accessory belts, you're done!

You can buy a complete head gasket kit from FCP Groton for $43 using part number 270689ELR. Don't go cheap with Scan Tech parts, insist on getting Elring.

Two things I would suggest doing while you've got the engine apart:
1. Replace the camshaft oil seal, or if you have the time, replace all three front oil seals (camshaft, intermediate shaft, and crankshaft). Extensive walkthrough in the following post:
http://www.brickboard.com/RWD/index.htm?id=1107930
2. Clean the entire crank case ventilation system top to bottom. The best thing you can do to ensure healthy operation of your engine aside from oil changes is to keep the ventilation system breathing freely. Clean out the flame trap holder and all tubes, and remove the fist-sized oil trap from the engine block and clean out all 3 oil ports. There will be a lot of dried oil in here that will be constricting the passegeways. More info is included in the above mentioned this post.
">post.

Lastly, you can make your temp gauge accurate again with a simple operation to bypass the failed compensation board that's located inside your instrument cluster. The compensation board was installed to help reduce/eliminate minor temperature fluctuations in the 240 temp gauges, but they tend to fail in their old age and give inaccurate temp readings like false overheats, spiking/dropping temps, or failing to warn you when you are overheating. (thanks to Art B. for the excellent picture walkthrough)