The former Gunner believes his old side have promise, but doesn't believe an FA Cup triumph and a runners-up finish in the league would represent progress.
The Gunners saw off Reading in the semi-finals last time out, and will face Aston Villa in the Wembley showpiece after they overcame Liverpool in the last four.
Arsenal are also in second place in the Premier League table and take on leaders Chelsea on Sunday. A win over Jose Mourinho’s side could see them spark an unlikely late title challenge.
They are more likely to finish as runners-up at best, but Nicholas says that and an FA Cup victory would not be a massive success.
“It would be a success, just like last season,” he said.
“You can’t tell me that because they’ve gotten to second place that things have moved on in a big way [but] Arsenal are getting closer. Come the summer they still two more players and I’ve been saying that for four or five seasons.”
Arsene Wenger has never beaten Mourinho in the Premier League, although given Arsenal’s form at the end of the season, while Chelsea are stuttering, now could be the perfect time to change that.
Nicholas has offered his opinion on that front as well, saying his old side must revert back to the kind of scenario that saw them beat Manchester City at the Etihad earlier in the season.
That game saw them concede possession to the Premier League champions and hit them on the break, and Nicholas says a similar strategy may work against Chelsea.
“I do feel that there are options for Arsene Wenger,” he added.
“He has to adapt, he has to go back to the scenario that says ‘well we’ve started winning against Manchester City which was the first big turnaround, I can have a more cautious approach.’ Arsenal don’t need 75% of the possession to win it, they have to be clever in their approach.”