haggisaggis,
I haven't read all the posts, just your OP, but wanted to offer my opinion.
I am a Teaching Assistant, starting a Primary Teaching Training course in September. I am also a private Reading Tutor. I don't specialise in dyslexia but personally, I would recommend you ignore the school-teacher's comments about using sight words, and persevere with phonics. It is the best way to teaching reading, and, for children who struggle, often the only way.
Jolly Phonics do a range of books where the letter shape is "cut out" (indented) of the page, so your dd can trace it with her finger. There is also an action for each letter-sound. Both these things will help her to remember which sound is which.
When she knows her sounds, encourage her to sound out words, as you have been doing. Begin with CVC words, then go on to CVCC and CCVC. There is guidance on the Jolly Phonics website on how to do this.
Ruth Miskin has a series of books that will be suitable for your dd when she knows the alphabet sounds and the consonant digraphs: th, sh, ch, ng. This is the link to the website: www.readwriteinc.com (sorry, my links never work). You can order the books there - they are less than £10 per set and you can buy the sets one at a time.
I am working with a 7 year old at the moment and he has had two and a half years of sight words in school before coming to me as a non-reader. If he had come two years ago he would pick up what I am teaching him so much quicker because he would not have learned so many bad habits - mainly guessing. I would not want this to happen to your daughter.
Good luck. You are doing the right thing and can teach your dd to read yourself. I started by teaching my son, three years ago, before I was a teaching assistant, and I knew nothing...
If I can help in any way, please CAT me or post on here.
HTH