You first will need to find a castle called "Battle Horn Castle" (I am not sure if it requires DLC, but I have shivering isles..) After you reached Battle Horn Castle, go to the training room, where the orc is.. Then inside the training room, there is a shooting area to shoot your bows, go in that room, and go behind the target that you shoot at.. Then use a light spell or Night eye, then you will see a candle, activate the candle behind the target, and a door in the wall will open, go inside, go in the door, and then there will be a skeleton thats powerful, and some type of mage with him aswell.. Kill them both and pick up the sword that the skeleton has, It is called "Dragon Sword" once you equipt it, it will give you a sword called "Dragon Breath". Its a two hit kill! And if you kill someone at the water front, YOU WILL GET AWAY WITH IT!
Thanks for reading my short tutorial on how to find the dragon sword, if you still can't find it, please watch this video here: http://www.youtube.com/watch?v=VxT_L1059qo