It's great that you can read music! I can understand sheet music, but I can't sit down and play a piece at tempo unless it's a simple single line melody like Twinkle, Twinkle or such. I get lost on even easy preludes and such - I have to dissect it note by note. On the other hand, I can take a chord chart and make it sound like a full arrangement on piano or guitar. Chord charts are my forte.

THEORY is what helps. I can play by ear blindly, BUT, if I know I'm in G Major, I know what notes I can use, what chords to generally expect, and how to extend these chords without guesswork - it just takes musical taste in the application. My advice: get a teacher and work on theory! It's single-handedly the most important thing you could learn - better than any lick or arpeggio, because most licks and arpeggios are derived from a theortical formula.