Hi Sharon,
1. Yes, we run the trace on the server that is being audited. The trace rollover argument of sp_trace_create specifies that when the trace file reaches it's max file size, the current trace file is closed and an new file is created. In the example I gave, the max file size is 5 mb.
2. As I mentioned, our trace is stopped once a day then restarted. Each time it's started it creates a new trace file with the current date as part of the filename. You don't need to stop the SQL Server service to stop the trace. Just use sp_trace_setstatus.
3. Yes, because the trace is stopped and restarted.