We are also reading mainly in German and I also found it very difficult to teach whole words in German so
we did it the phonics way.
Try to build up the phonological awareness of your son (beginning sounds, ending sounds, rhyming, ...).
There are several threads in this forum about phonological awareness.
I often spelled my children easy words again and again the same way as reading bear is doing that in English.
My kids learned the most at car drives (they couldn't run away ;-)) and just before sleeping directly before
the final good night. As you described, one day it just clicked and they could connect the letters to a word.
As complete German reading manual we then used "Das ABC der Tiere".

Thank you very much for the many ideas. I will try them the next days. Regarding the "Meet your letters"-DVD, it looks fantastic, but it is only available in English, as so many of that awesome EL stuff. We are only reading in German and I think English letter names would totally confuse her, but anyway that's a great idea for all english-reading people with similar problems.

My daughter (3) is reading phonetically (not fluent yet, but she can sound out almost every word), but she tends to confuse letters that are visually similar such as "d" and "b", "n" and "h" , "n" and "u", "d" and "a" ("a" in a font that looks likes a "d" with a shorter line at the right). She is perfectly able to separate the sounds auditively (in beginning and ending sounds, etc), so it seems to be only a visual problem. In several words she is self-correcting the false letter, such that the word matches a known real word. Did anyone also had such a problem? Will this problem vanish alone, when she gets a more proficient reader or should I do kind of "special exercises" with her to differentiate the single letters.

We like the following apps (not only maths apps, but all kind of "educational"):

Most games from ar-entertainment.net:
Magic Garden with letters and numbers
Snake-Puzzles and Dinosaurs puzzles (with numbers and letters)
My first tangrams
Alphabet puzzles, Numbers puzzles
Find the differences
My first weighting exercises: Very nice
Magic coloring: Coloring according to numbers
Telling time

Halloween Pumpkins - Matching pumpkins, nice

Kindergarten Kitty

Kids Socks plus, sorting of socks, t-shirt and shorts according to pattern, my kids like it very much.

Kids basics - Patterns, Kids basics - Shapes

Kids numbers - nice app for basic addition and substraction

Connect the dots

Zahlen lernen für Kinder, in German, don't know if there is also an english version, but very nice.

We will probably buy some more games of Smartgames:
http://www.amazon.com/s/ref=nb_sb_noss?url=search-alias%3Daps&field-keywords=smartgames

We already have Camelot Jr. (http://www.amazon.com/Smart-Tangoes-USA-SG-011/dp/B004TGPQDW/ref=sr_1_3?ie=UTF8&qid=1351840587&sr=8-3&keywords=smartgames) and Castle Logix (http://www.amazon.com/Smart-Tangoes-USA-SG-010/dp/B004TGVOOC/ref=sr_1_13?ie=UTF8&qid=1351840587&sr=8-13&keywords=smartgames), which my children really like to play with and which also pose relatively difficult logic exercises for the kids.

For free images and free pre-made flashcards try
http://www.mes-english.com/flashcards.php
or
http://www.esl-kids.com/flashcards/flashcards.html

The images are not high-quality (mostly comic images) and not always the best ones,
but many are useable.

We like the following apps:

Most games from ar-entertainment.net:
Magic Garden with letters and numbers
Snake-Puzzles and Dinosaurs puzzles (with numbers and letters)
My first tangrams
Alphabet puzzles, Numbers puzzles
Find the differences
My first weighting exercises: Very nice
Magic coloring: Coloring according to numbers
Telling time

Halloween Pumpkins - Matching pumpkins, nice

Kindergarten Kitty

Kids Socks plus, sorting of socks, t-shirt and shorts according to pattern, my kids like it very much.

Kids basics - Patterns, Kids basics - Shapes

Kids numbers - nice app for basic addition and substraction

Connect the dots

Zahlen lernen für Kinder, in German, don't know if there is also an english version, but very nice.

The photobooks are really a great idea. I will try them in the next weeks also for my older kids.
I have already shown my little daughter the infant stimulation cards from this website for
the first 4 months. She is interested in them and can locate the image on it (she will directly
steer her head in the direction of the image, so I think she is seeing at least some details).
She can also locate my homemade flashcards where the font is 4-5cm high.

Can I put sentences over several lines, or should that be avoided until the kid knows
how to read from left to right?

I'm trying to teach my 5 month old daughter to read by the Doman method. I show her words on flashcards
and the IPad. So far so good. Now I started to label several of her beginner picture books (you know these
first picture books, where's only one picture on each page and nothing else). I printed out the words in
as big as possible to fit in the book (about 1.5 - 2 cm high) without masking the picture and clue them
in the book with adhesive tape. This way I hope each time I read the book to her, I can point to the words.
I'm not really sure if she can already see such a small font and if she ever will look to the word and not
only to the image. In the next stage of picture books with more complex pictures and one or two
sentences on each page, I think I would stick only some sight words like cat, dog, etc in the picture
as the writing is often to small and complex for babies.

What do you think about such an approach to enlarge the exposure to sight words?
Did anyone of you try such labelling and would recommend it?

Yes, that's the way I also planned for the next months. There are so much super books in English available which
use i.e. only some sight words etc. Unfortunately there's nothing like that in German, as far as I researched.
There is a mass of first reader books, which requires the reader to use already all blends available in German,
so that's too much for my daughter right now.
I think I have to make some books on my own (a la Doman).
At this time we are using a German Reading Primer which is based on a syllable based approach. So at
first the reader learns to read things like ma, me, mi, mo, mu then la, le, li, lo, lu, ta, te, ti, to, tu and
all combinations of such syllables together like Mama, Timo, ... with some easy sight words like "is".
I think I will try to make her read these fluently at first...

Apart from that, we do a lot of reading (I read to her and her 4 year old brother (he is also reading, but slightly better already,
but he's using a lot of sight words)). We read almost everything, also a lot of easy books (recommended for about 2 year olds),
so they don't have to concentrate on the plot and can follow the text quite easily. One of the kids reads the title of the
book to me and at some points in the text they should read words they already know. Sometimes they read it to me, but they
are often also guessing based on the plot, without even trying to read them. Hoping this will get better in the future ...

My DD just turned 3 and is reading phonetically since about 2 months (it just "clicked" and she could blend the sounds
together from one day to the other). She can read most words consisting of up to 6 or 7 letters by sounding out each
letter and then blend them together (excluding some very difficult words with many special sounds - we are reading
in German). Some months ago she could read about 20 sight words, which she isn't using yet, she is simply sounding
out each word she sees, even her own name.

How did you proceed to make the reading fluent, without sounding out each letter? Will the sounding out
disappear automatically, when she will get more proficient in reading?

Thanks for your replies in advance, really an amazing forum here, I wish I had found it earlier ...