Can this sign be used for 'imagine' or 'imagination'?
Yes, this sign is commonly used interchangeably for 'fantasy', 'imagine', 'imagination', and sometimes 'invent'. The context of your sentence will help clarify which English word you mean.
Does it matter how far I move my hands?
The distance can indicate the scale of the fantasy. A small, brief movement might mean a passing thought, while a larger, more exaggerated movement can describe a wild, elaborate fantasy.
Do my palms have to face each other?
Yes, starting with your palms facing each other or slightly angled toward your head is standard. As your hands move up and out, they naturally stay in that relative orientation.