The 20-year-old Werribee man accused of the terrorism plot was described by police as one of their "high persons of interest".
Deputy Commissioner Shane Patton said they believed the man was trying to get an automatic rifle to "shoot and kill as many people as he could" around Federation Square, in Melbourne's CBD, during New Year's Eve celebrations.
Police said they moved in because the man had been having face-to-face meetings about getting a gun.
The man, who police said was connected to other extremists, did not manage to obtain one, Deputy Commissioner Patton said.
Federation Square is of the most popular spots in Melbourne to bring in the new year.
He is facing charges in relation to preparing to commit a terrorist attack and collecting documents to facilitate that attack.
The man is described as a Muslim, who is an Australian citizen with Somalian parents.
"We were monitoring this person. He has been subject to our active investigation and at no stage did he access a firearm - albeit that was his intention," Deputy Commissioner Patton said.
"This is a person would become particularly energised, for a lack of a better word, when overseas events occurred and would express a great deal of interest in committing an attack himself."
The man is currently being interviewed by police and is expected to be charged later today or tomorrow once the questioning is complete, he said.
One of the charges carries a maximum penalty of life in prison.
Police have applied for a time extension to question him further.
He said the man had accessed documents produced by Al Qaeda, including a "guidebook" on how to commit a terrorist act and how to use firearms.
New Year's Eve attack could have been 'horrendous'
Deputy Commissioner Patton said there was no ongoing threat for the upcoming Christmas and New Year's Eve period.
"We're quite confident that there's no risk or no threat to the Victorian community now that we have removed him from society and he's being interviewed," he said.
However Deputy Commissioner Patton said the potential of the attack could have been catastrophic.
"This is a person who's expressed an intention to try and kill as many people as he could through shooting them in the Federation Square area on New Year's Eve. Horrendous," he said.
Earlier police said the operation was ongoing but no other arrests were expected.
The man was arrested on Monday after police executed warrants at his family home in Werribee, and at a relative's home in Meadow Heights.
They also raided a small computer company in Footscray where the man worked part-time.
Police are still searching the man's home and it was "very much an open question" whether his relatives were also involved, Deputy Commissioner Patton said.
Police said the arrest was not linked to any previous operations.