Can this device connect via Bluetooth or does it have to be placed on the magnetic part where the cutout is?

You cannot use the iPad Magic Keyboard, or its Trackpad, unless it is docked with the iPad; the smart connector contacts that mate the two provides power and signalling between iPad and Keyboard/Trackpad.

If you wish to separate the iPad, you’ll have to use a standalone Bluetooth Keyboard and Trackpad. Apple have standalone Bluetooth versions of both - the [confusingly named] Magic Keyboard and Magic Trackpad 2 (both for Mac and iPad).

If you have a second generation Apple Pencil, it can only be paired and charged by “docking” the Pencil to the edge of a compatible iPad - these being an iPad Air4 or 2018/2020 model of iPad Pro.