The evaluation and fault diagnosis of a diesel engine’s health conditions without disassembly are very important for diesel engine safe operation. Currently, the research on fault diagnosis has focused on the time domain or frequency domain processing of vibration signals. However, early fault signals are mostly weak energy signals, and the fault information cannot be completely extracted by time domain and frequency domain analysis. Thus, in this article, a novel fault diagnosis method of diesel engine valve clearance using the improved variational mode decomposition (VMD) and bispectrum algorithm is proposed. First, the experimental study was designed to obtain fault vibration signals. The improved VMD method by choosing the optimal decomposition layers is applied to denoise vibration signals. Then the bispectrum analysis of the reconstructed signal after VMD decomposition is carried out. The results show that bispectrum image under different working conditions exhibits obviously different characteristics respectively. At last, the diagonal projection method proposed in this paper was used to process the bispectrum image, and the fourth order cumulant is calculated. The calculation results show that three states of the valve clearance are successfully distinguished.