Do a search on "fuel sending unit". There's lots of GREAT info in this forum on servicing and/or replacing this common source of problems. (I'd be willing to bet that this is the source of your dancing fuel gauge.)
My confidence comes from the fact that I just serviced and completely repaired the sending unit on my own '89 420SEL a few weeks ago. I suspect that if you're reasonably handy, use obvious caution around the gasoline, and follow the instructions contained on this forum, cleaning your sending unit will solve your problem.
Additionally, you might try adding some Techron(TM) to the fuel tank to help clean the system. Also, don't forget to change your fuel filter periodically.
Hope this helps... Good luck!