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I have difficulties to write more than simple dialogue that still works and is readable. So, I have two options here:
Which direction should I go?
Pick option three:
I struggled with writing dialogue for a long time, it bothered me that I could never make it sound like real conversation. As I've previously written I don't like to solve problems by seeing how other's have resolved them i.e. by reading how other's approach dialogue
My resolution was to realise that you don't need to make it sound like real conversation, you are using characters speech to convey story concepts. With that thought speech becomes a literary device that you employ in the appropriate situations to move your story along.
I started off with a desription of what I wanted them to say 'Julie talked to Mark about the train times' and put together a small exchange to convey that information.
Although there are also a number of novels that have relied on reported speech, so if that works for you, and the end product feels more comfortable, then perhaps that is better for you.
Keep writing dialogue. Not using dialogue is not an option. In rare cases, the characters might be fully established by their (mute) actions, but I repeat: This is rare. Although we usually rely on our sight much more heavily than on our other senses, it's mainly language through which we establish communication.
How to improve stiff, unnatural dialogue? My advise would be: Be honest. (This is similar to what @what suggested, just more character-driven. I don't care whether I can speak the way the character does, it simply must be true to the character.) To achieve this, I don't plot out the dialogue in advance, I simply have an idea of what the outcome of the conversation should be. Then I sit down, start to write, and just let the characters talk. The dialogue might be short or long, depending on what the character is going through in the scene - joy? sadness? anger? - and what his/her general communication strategies are. If you have a good understanding of your characters and a good idea of the plot - a plot that all characters are comfortable with, i.e. a plot that no character tries to break free from -, it will not be hard for your characters to come up with the topics and ideas that you have in mind for them.
Another thought: If you are interested in communication in general, maybe read some literature about that, sender-receiver theory and all. The best dialogue, on the other hand, that I could think of spontanesouly, would be in Oscar Wilde's "The Picture of Dorian Gray".
I find the key to dialog is subtext. People are generally communicating at more than one level, and if you don't convey that in your dialog, it sounds unnatural. Sexual tension, power struggles, rivalry, regret --all can be lurking under the surface of even the most innocuous smalltalk. Even if this isn't always the case in real life, it makes for more interesting conversations in fiction. Properly handled, your dialog shouldn't just be communication between the characters, it should also illuminate the relationship between the characters for the reader.
You could try looking into spoken language. Record some actual dialogue and then study it. Look at the differences between spoken and written language. Look at the linguistic areas called pragmatics and speech act theory.
You don't want to write completely realistic spoken language -- that is boring, often doesn't make sense, etc. -- but the knowledge you gain can help you write better dialogue.
Also, read it out loud.
