Farooqi, 30, was wanted in connection with an assassination attempt on president General Pervez Musharraf last December, and was indicted in the murder of Wall Street Journal reporter Daniel Pearl. He was also said to have been linked with the hijacking of an Indian Airlines aircraft taken to Kandahar in December 2000.
He was on top of Pakistan's most wanted list, with a bounty of Rs 20 million on his head.
Acting on a tip off, security forces cordoned off a house in Ghulam Hyder Shah Colony in the morning before raiding it. After an hour-long exchange of fire, Farooqi was reportedly shot dead when he tried to escape.
Seven other people in the housetwo men, two women and three childrenwere taken into custody, and several laptops, grenades and many documents were seized from the house.
"I can confirm that Amjad Farooqi has been killed in an encounter with security forces and we have also arrested three important terror suspects," said Information Minister Sheikh Rashid. "We will disclose the identity of his accomplices in few days. They are all Pakistanis and very important suspects."
President Musharraf had named Farooqi as the "Pakistani mastermind" of the December 25 assassination attempt, where two suicide bombers rammed their explosives-laden vehicles into his presidential motorcade, killing more than a dozen people. Musharraf escaped unhurt.
The attack came two weeks after a bridge was blown up in an attempt to kill Gen Musharraf while he was going to his official army house residence in Rawalpindi.
Farooqi was the lynchpin of the Al Qaeda network in Pakistan, and had been involved in the kidnap-murder of Daniel Pearl in Karachi in early 2002, the Dawn quoted an official as saying.
He had recruited the militants who kept Pearl in a shed on Karachi's outskirts after the reporter was abducted on January 23, 2002, as well as the trio who actually slit Pearl's throat before a video camera. But though he was indicted over Pearl's murder, he was never tracked down.
Farooqi, who joined the Harkatul Jihad-i-Islami when he was a teenager, was sent to Afghanistan for training in 1992 and had fought alongside the Taliban against the Northern Alliance.
His contacts with Al Qaeda leader Osama bin Laden and his inner coterie deepened after the Taliban conquered most of Afghanistan in 1996. He reportedly was very close to Khalid Sheikh Mohammad, Al Qaeda's number three and the alleged chief planner of the Sept 11, 2001, attacks. Mohammad was arrested in March 2003 near Islamabad.
Security officials described Farooqi as an "extremely intelligent and elusive terrorist operative," a master strategist who created cells of militants independent of each other.
He was also said to be a close associate of Libyan Abu Faraj Farj, operational chief of Al Qaeda in the region, who is still at large.